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IAS 12 Income Taxes 2011

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng IAS 12 Income Taxes

IFRS WORKBOOKS (1 million downloaded)

Welcome to IFRS Workbooks! These are the latest versions of the legendary workbooks in Russian and English produced by 3 TACIS projects, sponsored by the European Union (2003-2009) and led by PricewaterhouseCoopers. They have also appeared on the website of the Ministry of Finance of the Russian Federation.

The workbooks cover various concepts of IFRS based accounting. They are intended to be practical self-instruction aids that professional accountants can use to upgrade their knowledge, understanding and skills.

Each workbook is a self-standing short course designed for approximately of three hours of study. Although the workbooks are part of a series, each one is independent of the others. Each workbook is a combination of Information, Examples, Self-Test Questions and Answers. A basic knowledge of accounting is assumed, but if any additional knowledge is required this is mentioned at the beginning of the section.

Having written the first three editions, we want to update them and provide them to you to download. Please tell your friends and colleagues. Relating to the first three editions and updated texts, the copyright of the material contained in each workbook belongs to the European Union and according to its policy may be used free of charge for any non-commercial purpose. The copyright and responsibility of later books and the updates are ours. Our copyright policy is the same as that of the European Union.

We wish to especially thank Elizabeth Appraxine (European Union) who administered these TACIS projects, Richard J. Gregson (Partner, PricewaterhouseCoopers) who led the projects and all friends at Bankir.Ru for hosting the books.

TACIS project partners included Rosexpertiza (Russia), ACCA (UK), Agriconsulting (Italy), FBK (Russia), and European Savings Bank Group (Brussels). The help of Philip W. Smith (editor of the third edition) and Allan Gamborg, project managers and Ekaterina Nekrasova, Director of PricewaterhouseCoopers, who managed the production of the Russian version (2008-9) is gratefully acknowledged. Glyn R. Phillips, manager of the first two projects conceived the idea, designed the workbooks and edited the first two versions. We are proud to realise his vision.

Robin Joyce Professor of the Chair of International Banking and Finance Financial University under the Government of the Russian Federation

Visiting Professor of the Siberian Academy of Finance and Banking Moscow, Russia 2011 Updated

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 2 IAS 12 Income Taxes

CONTENTS

1 Introduction 3 2 IAS 12 for Banks 4 3 Permanent Differences 5 4 Definitions 6 5 Deferred Tax – basic idea 7 6 Tax Accounting – the process 15 7 Fair Value Adjustments 25 8 Deferred Tax Assets 33 9 Determine appropriate tax rates 37 10 Determine movement in deferred tax balances 45 11 Presentation 47 12 Accounting for Deferred Tax - Detailed Rules. .49 13 Disclosure 54 14 Appendix – Some IFRS / Russian Accounting Comparisons 60 15 Multiple Choice Questions 70 16 Answers to multiple choice questions...... 73 17 NUMERICAL QUESTIONS...... 74 18 ANSWERS TO NUMERICAL QUESTIONS...... 77 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 3 IAS 12 Income Taxes

1. Introduction IFRS 12 sets out to overcome this problem in terms of presentation so that financial statements prepared under Aim different tax regimes include the effect of taxes at the appropriate time. The aim of this workbook is to assist the individual in understanding the IFRS accounting treatment and IAS 12 prescribes the accounting treatment for income disclosures of Income Taxes, as detailed in IAS 12. taxes, and the tax consequences of: Definitions of the terms used are set in section 3 on page 4. (1) Transactions of the current period that are recorded the Deferred tax is making an accrual for tax, which is then financial statements; and reversed when the tax is paid. The purpose is to account for tax in the same accounting period as the economic event that (2) The future liquidation of assets and liabilities that are incurs the tax, regardless of when the tax is paid (or recorded only the balance sheet. recovered). It links the accounting system with the systems of taxation reported in the financial statements. If liquidation of those assets and liabilities will make future In simple terms, sales generally generate a tax charge. tax payments larger or smaller, IAS 12 generally requires an Revaluations generate a deferred tax charge (an accrual for undertaking to record a deferred tax liability (or deferred tax tax). asset).

Objective IAS 12 requires an undertaking to account for the tax The accounting profit may differ from the taxable profit as consequences of transactions, in the same manner that it each is compiled according to its own set of rules and accounts for the transactions: regulations.  For transactions recorded in the income statement, IFRS is a common set of guidelines for compiling the any related tax consequences are also recorded in financial statements but the tax law and tax code of Russia the income statement. stipulates how the tax liability will be calculated, and when it will be paid.  For transactions recorded directly in equity, any related tax consequences are also recorded directly in Tax is often only collected in arrears or in advance. When equity (for example, property revaluations under IAS this happens, there will be timing differences between when 16). the profit is reported and when the tax on it is paid. This generates a tax liability (or tax asset). http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 4 IAS 12 Income Taxes

The recognition of deferred tax assets, and liabilities, in a As bank accounting for income tax is based on the national business combination affects the amount of goodwill arising tax system, banks have little more than to follow the in that combination. presentation requirements of IAS 12, using the figures already compiled. Differences may occur in the treatment of IAS 12 also covers: carried forward tax losses and tax credits. 1. Recognition of deferred tax assets arising from unused tax losses, or unused tax credits, The major additional work is the deferred tax computations, 2. Presentation of income taxes, and effectively accruing for future tax on revaluations. In Russia, 3. Disclosure of information relating to income taxes. there is a requirement to account for tax (PBU 18), but banks have, so far, been exempt from this requirement. Scope IAS 12 should be applied in accounting for income taxes In simple terms, sales generally generate a tax charge. including: Revaluations generate a deferred tax charge (an accrual for tax). The revaluations gains will be effectively shown as 80% 1. All domestic, and foreign, taxes based on taxable profits. of the total gain, having accrued deferred tax at 20%.

2. Taxes, such as withholding taxes payable by a subsidiary, Banks already revalue their currency positions daily in associate, trade investment or joint venture on Russia, but generally have not revalued their financial distributions to the reporting undertaking. instruments to reflect the latest market prices.

IAS 12 does not deal with the methods of accounting for Deferred tax will need to be accrued for all revaluations of government grants, or investment tax credits (see IAS 20). financial instruments, where this is required by IFRS 9 Financial Instruments, unless the profits will not be liable for However, IAS 12 does deal with the accounting for temporary tax. differences that may arise from such grants, or investment tax credits each of which alter the timing of when the tax is Deferred tax will need to be accrued for the fair values of payable. assets computed in accounting for acquisitions and revaluations of property.

2 IAS 12 for Banks Where transformation from Russian accounting to IFRS moves profit from one period to another and the tax payment Accounting for income tax is firmly based on the national tax does not move, deferred tax will need to be accrued. This will system. especially apply to finance leases (IAS 17 Leases) which are http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 5 IAS 12 Income Taxes

not recognised for tax purposes as any different from When reviewing financial statements of clients and operating leases. correspondent banks, banks will need to ensure that deferred tax has been fully accrued.

EXAMPLE-Permanent Differences 3 Permanent Differences Your firm receives a tax- free $4million grant to employ more staff. Permanent differences between the financial profit and taxable profit arise when income is not taxable or expenses It is later also fined $1m for environmental misuse, after illegally are not allowed for tax. discharging chemicals into a river. The fine cannot be deducted for tax. A government grant may be a gift that is not taxed. Government bonds often provide tax-free interest income, or The financial statements will reflect these items, but your tax may be taxed at a lower rate than the standard income tax computation will exclude them, or record that no tax is payable rate for companies. Fines paid by an undertaking may not be nor receivable. Your tax computation will reconcile these tax-deductible. adjustments to the accounting profit. The tax computation for the period will calculate the impact of No deferred tax needs to be calculated for permanent these transactions. differences. This is because deferred tax is an accrual of tax, and there will be no further tax to be accrued. No further accounting is needed and no deferred asset or liability will be recorded. Assuming that both items are taken into profit in full in the same period, the tax computation could reflect: Definitions In the following examples, I/B refer to Income Statement and Balance Sheet (SFP). Accounting profit (‘net profit before tax’) $m Accounting profit is net profit for a period, before deducting Accounting Profit 486 tax. Less grant -4 TAXABLE PROFIT (OR TAX LOSS) Plus fine +1 Taxable profit (tax loss) is the profit (loss) for a period, =Taxable profit 483 calculated according to the rules of the tax authorities, upon Tax charge = 483 * 20% = 96,600 which income taxes are payable (recoverable).

I/B DR CR http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 6 Tax expense I 96,600 Accrual for income tax B 96,600 Tax expense for the period IAS 12 Income Taxes

TAX EXPENSE (OR TAX INCOME) Tax expense (tax income) is the total amount included in the (1) taxable temporary differences that will increase taxable net profit (or loss) for the period, in respect of current tax, and profit of future periods, when the carrying amount of deferred tax. the asset (or liability), is liquidated; or

Tax expense (tax income) comprises both current tax (2) deductible temporary differences that will reduce expense (income) and deferred tax expense (income). taxable profit (tax loss) of future periods, when the carrying amount of the asset (or liability) is liquidated. Current tax Current tax is the total of income taxes payable (recoverable) Tax base in respect of the taxable profit (loss) for a period. The tax base of an asset (or liability) is the value of that asset (or liability), for tax purposes. This may be the written down Deferred tax liabilities value of a fixed asset for tax basis. Others are described Deferred tax liabilities are the amounts of taxes payable, in below. future periods, in respect of taxable temporary differences. The tax base is the amount that will be deductible for tax DEFERRED TAX ASSETS purposes over the life of the asset.

Deferred tax assets are the taxes recoverable, in future EXAMPLE - Determine the tax base of assets and liabilities periods, in respect of: Issue (1) deductible temporary differences (accruals of tax An asset’s tax base is the amount that will be deductible for tax receivable); purposes against any taxable economic benefits that will flow to an entity when it recovers the asset’s carrying amount. If those (2) unused tax losses; and economic benefits will not be taxable, the asset’s tax base is equal to its carrying amount. (3) unused tax credits. How should management calculate the tax base of a dividend Temporary differences receivable balance? Temporary differences are differences between the carrying amount of an asset (or liability) in the balance sheet, and its Background tax base. Entity G’s management has recognised, in G’s single-entity financial statements, a dividend receivable of 100,000 from a Temporary differences may be either: wholly-owned subsidiary. The dividend is not taxable. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 7 IAS 12 Income Taxes

1.100 at the period end, recording a profit of 100. The Solution financial asset is then sold in Year 2 for 1.100, its revalued Management should calculate the tax base of the dividend amount. receivable as follows: Year 1 Year 2 Income 100 0 Tax expense @ 20% 0 -20 Carrying amount 100,000 Net profit 100 -20

Future taxable - (the dividend is not taxable) The tax expense is a direct result of the income in period 1. amounts Readers of financial statements should be made aware that a tax charge will be levied in the following year. Future deductible - amounts Deferred tax is used to identify future tax payments generated by transactions in the current year – it is an accrual for tax, Tax base 100,000 and like all accruals, will be reversed when the tax is actually paid. 5 Deferred Tax – basic idea Year 1 Year 2 Deferred tax is an accrual for tax, receipt or payment, created Income 100 0 when the economic activity and the tax impact are either in Tax expense @ 20% 0 -20 different periods, or do not completely match in amounts or Deferred tax @ 20% -20 20 time period. Net profit 80 0

Accounting for tax is simpler when the transaction is booked The deferred tax reverses over time (and will thus disappear). for both accounting and tax purposes in the same year. In This provides a more comprehensive picture to readers. such a case income tax is recorded and no deferred tax Without the deferred tax accrual, profits in Year 1 would be needs to be accrued. overstated, with the risk that dividends might be higher than the undertaking could afford. If a transaction takes place in year 1 and tax is paid in year 2, year 1 will show a transaction without a tax charge, and year In this case, it creates an accrual of the tax charge in year 1 2 will show a tax charge without a transaction: to link with the timing of the transaction.

In this example, a financial asset (at fair value through profit It is reversed in year 2 to reflect that tax has been accrued in and loss) is purchased for 1.000 in Year 1 and revalued at year 1, even though it was charged in year 2. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 8 IAS 12 Income Taxes

On the balance sheet, this deferred tax would be shown as a liability (accrual) at the end of period 1. It will disappear at the EXAMPLE - the cash is received and taxed in year 1, but end of period 2. the income is split between years 1, 2 and 3. This might occur when an advance payment is received for a long- EXAMPLE - tax is paid on receipt of the money in term contract. period 1, but only treated as income in period 2. Year 1 Year 2 Year 3 Year 1 Year 2 Income 200 200 200 Income 0 100 Tax expense @ -120 0 0 Tax expense @ -20 0 20% 20% Net profit 80 200 200 Net profit -20 100 The income is the same for each year, but the net profit In year 1 there is a tax charge without a changes due to the tax payment. The income in years 2 transaction. In year 2 there is a transaction without & 3 is taxed in the first year. a tax charge. Again, we use deferred tax to link the transaction Deferred tax is used to apportion the tax charge to match to the tax charge. the income: Year 1 Year 2 Year 1 Year 2 Year 3 Income 0 100 Income 200 200 200 Tax expense @ -20 0 Tax expense @ -120 0 0 20% 20% Deferred tax @ +20 -24 Deferred tax @ +80 -40 -40 20% 20% Net profit 0 80 Net profit 160 160 160 In this case, deferred tax accrues a tax credit in The total tax charge for year 1 will be 40 (120 minus 80), year 1 to carry forward the tax paid to period 2 to so the Income Statement for each year will be the same. link with the timing of the transaction. The accrual The deferred tax reduces the tax charge in year 1, but is reversed in year 2. increases it in years 2 & 3.

On the balance sheet, this deferred tax would be shown as an asset (or prepayment of tax) at the end of period 1. It will disappear by being reversed at the end of period 2. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 9 IAS 12 Income Taxes

EXAMPLE -expenses attract tax credits (‘tax EXAMPLE- tax is credited on payment of the income’). money in period 1, but only treated as an expense in period 2. If a transaction takes place in year 1 and tax is Year 1 Year 2 credited in year 2, year 1 will show a transaction Expense 0 -100 without a tax credit, and year 2 will show a tax Tax income @ +20 0 credit without a transaction: 20% Year 1 Year 2 Net profit +20 -100 Expense -100 0 In year 1 there is a tax credit without a transaction. Tax income @ 0 +20 In year 2 there is a transaction without a tax credit. 20% The tax will be shown as a prepayment. Net profit -100 +20 The tax income, or benefit of paying less tax due to Again, we use deferred tax to link the transaction to the expense, is a direct result of the expense in the tax credit. period 1. Readers of financial statements should Year 1 Year 2 be made aware that tax will be credited in the Expense 0 -100 following year. Tax income @ +20 0 20% Deferred tax is used to accrue future tax credits Deferred tax @ -20 +20 generated by transactions in the current year. 20% Year 1 Year 2 Net profit 0 -80 Expense -100 0 In this case, it accrues a tax credit in year 1 to Tax income @ 0 +20 carry forward the tax paid to period 2 to link with 20% the timing of the transaction. It is reversed in year Deferred tax @ +20 -20 2. 20% Net profit -80 0 On the balance sheet, this deferred tax would be EXAMPLE- an advance payment on a construction shown as an asset at the end of period 1. It will contract. disappear at the end of period 2 by being reversed. The cash is paid and credited for tax in year 1, but the expense is split between years 1, 2 and 3. Year 1 Year 2 Year 3 Expense -200 -200 -200 http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 10 IAS 12 Income Taxes

Tax income @ +120 0 0 20% Net profit -80 -200 -200 The expense is the same for each year, but the net profit changes due to the tax credit. The expense in years 2 & 3 is credited for tax in the first year.

Deferred tax is used to apportion the tax credit by accrual to match the expense: Year 1 Year 2 Year 3 Expense -200 -200 -200 Tax income @ 120 0 0 20% Deferred tax @ -80 +40 +40 20% Net profit -160 -160 -160 The total tax credit for year 1 will be 40 (120 minus 80), so the Income Statement for each year will be the same, matching the economic reality. The deferred tax reduces the tax credit in year 1, but increases it in years 2 & 3.

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 11 1 2 3 4 5 6 7 8 9 10 11 12 13 Calculation (2)/10 (2)-(4) (2)/12 (2)-(7) (4)-(7) (9) x 24% (3 - 6) x 24% (6) x 24% (11)+(12) DEFERRED TAX TAX- DEFERRED DEPRECIATION ALLOWANCE TIMING BALANCE TAX-INCOME CURRENT TOTAL YEAR COST EXPENSE NET (CREDIT) TAX BASE DIFFERENCE SHEET STATEMENT TAX TAX Year Cum Year Cum 1 6 000 600 600 5 400 500 500 5 500 100 24 24 120 144 2 600 1200 4 800 500 1000 5 000 200 48 24 120 144 3 600 1800 4 200 500 1500 4 500 300 72 24 120 144 4 600 2400 3 600 500 2000 4 000 400 96 24 120 144 5 600 3000 3 000 500 2500 3 500 500 120 24 120 144 6 600 3600 2 400 500 3000 3 000 600 144 24 120 144 7 600 4200 1 800 500 3500 2 500 700 168 24 120 144 8 600 4800 1 200 500 4000 2 000 800 192 24 120 144 9 600 5400 600 500 4500 1 500 900 216 24 120 144 10 600 6000 0 500 5000 1 000 1 000 240 24 120 144 11 0 500 5500 500 500 120 -120 120 0 12 0 500 6000 0 0 0 -120 120 0

EXAMPLE - the purchase of a building in year 1. See table above.

Depreciation is charged in years 1-10, after which the building is fully depreciated. The tax allowance is spread over years 1-12.

In years 1-10, depreciation is more than the tax allowance. In years 11 and 12, tax credits are received even though no depreciation is charged. This creates timing differences.

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng By charging deferred tax in years 1-10, and crediting deferred tax in years 11 and 12, the total tax for years 1-10 is equalised each year and matches the depreciation. In years 11 and 12, there is no total tax which matches the lack of depreciation in these years.

13 www.banks2ifrs.ru DR/CR 0 1 2 3 4 Tax -3000 Balance Sheet Amortisation 750 750 750 750 Cost 3000 Amortisation -1000 -1000 -1000 0 Tax Base -3000 -2250 -1500 -750 0

Off-Balance- Income Sheet Statement Tax -3000 Amortisation 750 750 750 750 Amortisation 100% 1000 1000 1000 0 Tax @ 2 4 % -180 -180 -180 -180 Tax Base -3000 -2250 -1500 -750 0 820 820 820 -180 Deferred tax Income Net profit/loss 76% 760 760 760 0 Statement The first step is to calculate the net loss as 76% of the expense for each Amortisation 1000 1000 1000 0 period. Tax @ 2 4 % -180 -180 -180 -180 820 820 820 -180 DR/CR 0 1 2 3 4 Deferred tax Balance Sheet Net profit/loss Cost 3000 Amortisation -1000 -1000 -1000 0 In the above example, a computer is bought for 3.000 with an economic life of 3 years, but the tax benefit will be spread over 4 years. The tax base is Off-Balance- shown as the tax benefit less is accumulated amortisation. (The income Sheet statement is an extract, excluding other items.) Tax -3000 Amortisation 750 750 750 750 This creates 2 problems of presentation: the loss after tax is NOT at 76% (100-24), and in year 4 there is a tax credit without any economic activity. Tax Base -3000 -2250 -1500 -750 0

Income DR/CR 0 1 2 3 4 Statement Balance Sheet Cost 3000 Amortisation 100% 1000 1000 1000 0 Amortisation -1000 -1000 -1000 0 Tax @ 2 4 % -180 -180 -180 -180 820 820 820 -180 Off-Balance- Deferred tax CR -60 -60 -60 180 Sheet http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng Net profit/loss 76% 760 760 760 0 Balance Sheet 60 60 60 -180 Debit Debit Debit Credit The second step is to compute the deferred tax as the difference between the net loss and the loss after tax. Identify whether the entry for Year 1 is a The cumulative figure shows the number that will be seen in the debit or a credit. balance sheet.

DR/CR 0 1 2 3 4 In this example, the balance sheet entry is a debit. A debit in the Balance Sheet balance sheet is an ASSET, so the result is a deferred tax Cost 3000 Amortisation -1000 -1000 -1000 0 asset.

Off-Balance- At the end of year 4, the balance on the balance sheet is Sheet eliminated – a control check that the deferred tax accrual has Tax -3000 been reversed. Amortisation 750 750 750 750 In the next example, a security is bought for 1.000 with an Tax Base -3000 -2250 -1500 -750 0 economic life of 5 years, but the tax benefit will be spread over 4 years. The tax base is shown as the tax benefit less is Income Statement accumulated amortisation. (The income statement is an extract, excluding other items.) Amortisation 100% 1000 1000 1000 0 Tax @ 2 4 % -180 -180 -180 -180 This creates 2 problems of presentation: the loss after tax is 820 820 820 -180 NOT at 76% (100-24), and in year 5 there is economic activity a Deferred tax CR -60 -60 -60 180 tax credit without a tax credit. 76% 760 760 760 0 Balance Sheet DR/CR 0 1 2 3 4 5 Deferred tax DR 60 60 60 -180 Balance Sheet Asset / liability??? Cost 1000 Amortisation -200 -200 -200 -200 -200 Cumulative 60 120 180 0 Off-Balance-Sheet The entry to the balance sheet for each year is computed by double entry Tax -1000 bookkeeping: Amortisation 250 250 250 250 0 Year 1 Year 2 Year 3 Year 4 Income Statement -60 -60 -60 180 Tax Base -1000 -750 -500 -250 0 0 Credit Credit Credit Debit 15 www.banks2ifrs.ru Income Statement Deferred tax -12 -12 -12 -12 48 Asset / liability??? Amortisation 100% 200 200 200 200 200 Tax @ 2 4 % -60 -60 -60 -60 0 Cumulative CR -12 -24 -36 -48 0 140 140 140 140 200 Deferred tax The entry to the balance sheet for each year is computed by Net profit/loss 76% double entry bookkeeping: Balance Sheet Deferred tax Year 1 Year 2 Year 3 Year 4 Year 5 Asset / liability??? Income Statement 12 12 12 12 -48 Cumulative Debit Debit Debit Debit Credit Balance Sheet -12 -12 -12 -12 48 Following the procedure of the previous example: Credit Credit Credit Credit Debit

DR/CR 0 1 2 3 4 5 Balance Sheet The cumulative figure shows the number that will be seen in the Cost 1000 balance sheet. Amortisation -200 -200 -200 -200 -200 In this example, the balance sheet entry is a credit. A credit in Off-Balance-Sheet the balance sheet is a liability, so the result is a deferred tax Tax -1000 liability. Amortisation 250 250 250 250 0

Tax Base -1000 -750 -500 -250 0 0 At the end of year 5, the balance on the balance sheet is eliminated – a control check that the deferred tax accrual has Income Statement been reversed.

Amortisation 100% 200 200 200 200 200 From these examples, we can conclude that if management Tax @ 2 4 % -60 -60 -60 -60 0 accelerates depreciation faster than the tax authorities, a 140 140 140 140 200 deferred tax ASSET will arise. Deferred tax DR 12 12 12 12 -48 Net profit/loss 76% 152 152 152 152 152 In contrast, if management depreciates an asset over a longer period than the tax authorities, a deferred tax LIABILITY will Balance Sheet 16 www.banks2ifrs.ru arise. ix) decide whether offset of deferred tax assets and liabilities between different group undertakings is appropriate in the The use of deferred tax does not change the dates of payment consolidated financial statements; and of any tax. It is an extension of the matching (accruals) concept used in IFRS. x) record deferred tax assets and liabilities, with the net change recorded in income or equity as appropriate. The current tax expense (or income) is the amount payable (or 6 Tax Accounting – the process receivable) as calculated in the tax return, plus any adjustment to deferred tax. Tax accounting comprises the following steps: The current tax expense is recorded in the income statement, i) calculate and record current income tax payable (or except any tax relates to a transaction that is recorded in equity receivable); rather than the income statement. For example, any tax related to the revaluation of property, plant ii) determine the tax base of assets and liabilities; and equipment should be recognised in equity. EXAMPLE- Tax expense split between the income statement iii) calculate the differences between (the accounting) carrying and equity. amount of assets and liabilities and their tax base to determine Your tax computation shows an expense of $87m for the year, of temporary differences; which $3m relates to a property revaluation under IAS 16. I/B DR CR iv) identify temporary differences that are not recorded due to Tax expense – income statement I 84m specific exceptions in IFRS; Tax expense-revaluation reserve B 3m Tax accrual B 87m v) calculate the net temporary differences; Tax expense split between the income vi) review net deductible temporary differences and unused tax statement and equity losses to decide if recording deferred tax assets is correct; If the tax already paid exceeds the tax due for the period, the vii) calculate deferred tax assets and liabilities by applying the excess will be recorded as an asset, assuming it is recoverable. appropriate tax rates to the temporary differences; EXAMPLE- Tax expense: Prepayment You have paid $100m as a tax prepayment. viii) determine the movement between opening and closing Your tax computation shows an expense of $87m for the year, of deferred tax balances; which $3m relates to a property revaluation. I/B DR CR 17 www.banks2ifrs.ru Tax prepayment B 100m Your building is to be depreciated over 20 years for Cash B 100m accounting purposes, but the tax authorities insist on a Recording tax prepayment minimum life of 30 years for this type of building. Tax expense – income statement I 84m Tax expense-revaluation reserve B 3m Whilst the accounting records will reflect the 20-year Tax prepayment B 87m depreciation period, the tax base will use the 30-year Tax expense split between the income depreciation model. statement and equity, matched against the tax prepayment i) Revenue received in advance

A tax loss, that can be carried back to recover tax of a previous Special rules apply to liabilities that represent revenue received period, should be recorded as an asset in the period in which in advance. the tax loss occurs. The tax base is equivalent to:

EXAMPLE- Tax loss: asset -the liability's carrying amount, if the revenue is taxable in a Your tax computation shows a loss of $6m for the year, which can subsequent period; be carried back to recover tax of a previous tax period. I/B DR CR EXAMPLE- Revenue received in advance Revenue is taxed in a later period. In year 1, it has a tax base of Tax recoverable B 6m 100. Tax income I 6m I/B DR CR Recording recoverable tax loss Cash B 100 The tax base of an asset or liability is the amount attributed to it Deferred revenue B 100 for tax purposes. Receipt of cash-period 1 The depreciation for an item of property plant or equipment on Deferred revenue B 100 an accounting basis may differ from the calculation on a tax Revenue I 100 basis. Tax expense @ 20% I 20 Current tax liability B 20 EXAMPLE- Different depreciation rates for accounting Revenue recognition and tax expense-period and tax 2

-nil if the revenue is taxed in the period received.

18 www.banks2ifrs.ru Entity A receives royalties from users of its licensed technology of 25,000 relating to the following financial year. Royalties are taxed EXAMPLE- Revenue received in advance on a cash receipts basis. Revenue is taxed in the same period. In year 1, it has a tax base of The royalty income is deferred in the balance sheet until the 0. period it relates to. There is a timing difference as the revenue is recognised for tax before it is recognised for accounting. Solution I/B DR CR Management should calculate the tax base of the royalties Cash B 100 received in advance as follows: Deferred revenue B 100 Deferred tax asset @ 20% B 20 Carrying amount 25,000 Current tax liability B 20 Receipt of cash and tax payment -period 1 Deferred revenue B 100 (Tax was assessed when Revenue I 100 Revenue not taxable (25,000) revenue was received) Tax expense @ 20% I 20 in future period Deferred tax asset B 20 Revenue and tax expense recognition -period 2 Tax base - EXAMPLE - Revenues received in advance

Issue Entity A has a deductible temporary difference of 25,000 (25,000 The tax base of a liability is its carrying amount less any amount - nil). Management should recognise a deferred tax asset in that will be deductible for tax purposes in respect of that liability in respect of the deductible temporary difference. future periods. In the case of revenue received in advance, the tax base of the resulting liability is its carrying amount, less any EXAMPLE - Tax base of long service leave provision amount of revenue that will not be taxable in future periods. Issue How should management calculate the tax base of revenue The tax base of a liability is its carrying amount less any amount received in advance? that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue received in advance, the Background tax base of the resulting liability is its carrying amount, less any 19 www.banks2ifrs.ru amount of revenue that will not be taxable in future periods. Research and development costs may be expensed in the current period, but deductible for tax purposes over subsequent How should management calculate the tax base of a long service periods. The tax base reflects the amount of the deduction that leave provision? can be claimed in future periods.

Background EXAMPLE-Research and development costs Entity C’s management has recognised a liability under IAS 19 for You spend $20m on research in the current period, and it is treated accrued long service leave of 150,000 at the balance sheet date. as an expense. Tax authorities only allow the expense to be No deduction will be available for tax until the long service leave deducted over a 4-year period. Only $5m is allowed in this period. is paid. The remaining $15m is the tax base at the end of year 1, and will be Solution allowed over the next 3 years. Management should calculate the tax base of the long service leave provision as follows: I/B DR CR Carrying amount 150,000 Research cost I 20m Cash B 20m Future deductible amounts (150,000) (a deduction will be received for tax purposes when paid) Tax credit @ 20% I 4m Current tax liability (reduction) B 1m Future taxable amounts - Deferred tax asset B 3m Research cost and tax income -period 1 Tax base - Current tax liability (reduction) B 1m Deferred tax asset B 1m Entity C has a deductible temporary difference of 150,000 Tax income -period 2 (and the same for (150,000 - nil). Management should recognise a deferred tax periods 3 & 4) asset in respect of the deductible temporary difference. EXAMPLE - Deferred tax on provision for general insurance ii) Amounts not reflected in the balance sheet risk

Deductible or taxable amounts may arise from items that are not Issue recorded in the balance sheet. Some items have a tax base but are not recognised as assets and liabilities in the balance sheet. The difference between the 20 www.banks2ifrs.ru tax base and the carrying amount of nil is a temporary difference recognised in the financial that results in a deferred tax balance. statements) Future deductible - (the provision is deductible Should management recognise a deferred tax liability regarding amounts for tax purposes in the provision for general insurance risk that was not included in the current period) financial statements but which was claimed in the tax accounts? Future taxable 3,500 (the expense of future amounts utilisation of the provision Background will not be deductible for tax An insurance entity’s management has recognised in the income purposes) statement net premium income of 5,000 during the year. Tax base 3,500 Management is permitted for tax purposes to set up a provision for general insurance risks of 10% of the entity’s net premium income. Management claims this benefit in full and recognises a The entity has a taxable temporary difference of 3,500 (nil - provision of 500 during the year in the tax accounts. It does not 3,500). Management should recognise a deferred tax liability in recognise the provision in the entity’s financial statements. respect of the taxable temporary difference.

The accumulated provision in the tax accounts has been IFRS adopt the balance sheet model. Management should increasing every year. The balance at the balance sheet date is therefore recognise the deferred tax liability even though a future 3,500, net of any utilisation of the provision. The possibility of a liquidation of the entity might appear to be remote. decrease in this provision is remote, probably occurring only if the iii) Investments within groups entity was liquidated. The acquisition of an investment in a subsidiary, associate, Solution branch or joint venture will give rise to a tax base for the Yes, management should recognise a deferred tax liability in investment in the parent undertaking's financial statements. The respect of this provision with the corresponding entry to the tax tax base is often the cost paid. charge in the income statement. Differences between the tax base and the carrying amount will Management should calculate the tax base of the provision as arise in the periods after acquisition due to changes in the follows: carrying amount. The carrying amount will change, for example, if the investment is accounted for using the equity method, or if an impairment charge is recorded. Carrying amount - (the provision is not 21 www.banks2ifrs.ru EXAMPLE- Investment in subsidiary and impairment non-depreciable assets (such as land) can only reflect the tax You buy a subsidiary for $70m. Trading is poor, and you book an consequences that would follow from the sale of that asset. impairment charge of $10m. This is because the asset is not depreciated. Therefore, for tax The tax base is $70m, representing the cost. It is not adjusted for purposes, the carrying amount (or tax base) of the non- the impairment charge, creating a difference between the tax base depreciable asset reflects the value recoverable from the sale of and the carrying amount of $10m. the asset. I/B DR CR Investment in subsidiary B 70m Calculate temporary differences Cash B 70m Recording purchase of subsidiary The concept of temporary differences is central to deferred tax Impairment of subsidiary I 10m accounting. This means that the difference will eventually Investment in subsidiary B 10m reverse. Temporary may not mean short-term: it may take many Tax income (deferred tax) @ 20% I 2m years until the accruals are completely reversed. Deferred tax asset B 2m Recording impairment charge and (deferred) Temporary differences arise when the carrying amount of an tax charge. asset or liability differs from its tax base. The deferred tax asset will be released when the investment is finally liquidated and the A deductible temporary difference generates a deferred loss is allowed for tax. tax asset (which will reduce future payments) and a iv) Expected manner of liquidating assets and liabilities taxable temporary difference gives rise to a deferred tax liability The measurement of deferred tax liabilities and assets should (which will increase future payments). reflect the way in which management expects to liquidate the underlying asset or liability. Taxable temporary differences occur when tax is charged in a period after the accounting period suffers the expense in the For example, in some countries a different tax rate may apply financial accounts. depending on whether management decides to sell or use the asset. Taxable temporary differences arise when:

However, the deferred tax liabilities or assets associated with -an asset's carrying amount is greater than its tax base; or when 22 www.banks2ifrs.ru -a liability's carrying amount is less than its tax base. Interest revenue I 700 Deferred tax liability B 140 Many taxable temporary differences arise because the Tax expense @ 20% (deferred tax) I 140 transaction is recognised in different periods for tax and Recognition of revenue and application of accounting purposes. deferred tax- period 1 Cash B 700 Interest receivable I 700 Tax expense @ 20% I 140 EXAMPLE- Deductible Temporary Difference Cash – tax payment B 140 interest revenue is included in pre-tax accounting profit on a time- Deferred tax liability B 140 apportionment basis but may be taxable on a cash basis. Tax expense I 140 I/B DR CR Receipt of cash and tax payment- period 2 Cash B 300 Interest revenue I 100 Deferred interest revenue B 200 EXAMPLE- Taxable Temporary Difference ii) revenue from the sale of goods is included in pre-tax accounting Tax expense @ 20% I 20 profit when goods are delivered, but may be included in taxable Deferred tax asset B 40 profit when cash is collected. Current tax liability B 60 Goods sold for 100 delivered in year 1, cash collected and taxed in Receipt of cash and tax payment -period 1 year 2. Partial recognition of revenue and tax I/B DR CR Deferred interest revenue B 100 Accounts receivable B 100 Interest revenue I 100 Revenue I 100 Tax expense @ 20% I 20 Deferred tax liability B 20 Deferred tax asset B 20 Tax expense (deferred tax) @ 20% I 20 Interest revenue and tax expense recognition Receipt of cash and tax recognition -period 2 (Same for period 3) -period 1 Cash B 100 EXAMPLE- Taxable Temporary Difference Accounts receivable B 100 i) interest revenue is included in pre-tax accounting profit when Deferred tax liability B 20 accrued but may be taxable on a cash basis. Current tax liability B 20 I/B DR CR Receipt of cash and tax liability Interest receivable B 700 23 www.banks2ifrs.ru recognition -period 2 Deferred tax liability B 20 Development costs capitalised but EXAMPLE- Taxable Temporary Difference allowed for tax credit -period 1 iii) accumulated accounting depreciation may differ from cumulative Depreciation – development costs I 25 tax depreciation because depreciation is accelerated for tax Accumulated depreciation B 25 purposes; Accounting depreciation is 100 and for tax purposes it is Deferred tax liability B 5 150. Tax income @ 20% I 5 I/B DR CR Depreciation and adjustment for tax Depreciation I 100 -period 2 Accumulated depreciation B 100 Current tax (reduction) 150 @ 20% B 30 Tax income I 20 Deferred tax liability B 10 EXAMPLE- Taxable Temporary Difference Depreciation and higher tax credit v) prepaid expenses for accounting purposes may have been -period 1 deducted on a cash basis in determining the taxable profit. Depreciation I 100 I/B DR CR Accumulated depreciation B 100 Cash B 100 Current tax (reduction) 50 @ 20% B 10 Prepaid expenses B 100 Tax income I 20 Current tax (reduction) @ 20% B 20 Deferred tax liability B 10 Deferred tax liability B 20 Depreciation and lower tax credit Payment of cash and tax credit -period 1 -period 2 Expense I 100 Prepaid expenses B 100 EXAMPLE- Taxable Temporary Difference Deferred tax liability B 20 iv) development costs have been capitalised for accounting Tax income (deferred tax) @ 20% I 20 purposes and will be amortised to the income statement, but may Cost and tax income recognition -period have been deducted as an expense in determining taxable profit in 2 the period in which they were incurred. Amortised over 4 years The tax laws of the undertaking's operations will determine the starting from the year after they were incurred. I/B DR CR temporary differences. Development costs (capitalised) B 100 Cash B 100 Deductible temporary differences occur when tax is charged in Current tax (reduction) @ 20% B 20 24 www.banks2ifrs.ru a period after the accounting period suffered the expense in the Deferred tax asset B 10 Depreciation and higher tax credit financial accounts. -period 2

Deductible temporary differences arise when: EXAMPLE- Deductible Temporary Difference -an asset's carrying amount is less than its tax base; or when ii) employee expenses, or pension payments, are recorded when incurred for accounting purposes and but only for tax purposes -a liability's carrying amount is greater than its tax base. when paid in cash. Like taxable temporary differences, many deductible temporary I/B DR CR differences arise from differences in the timing of recording the Pension expense I 100 underlying transaction for accounting and tax purposes. Accrual B 100 Deferred tax asset B 20 Deductible temporary differences examples: Tax income (deferred tax) @ 20% I 20 Accrual of pension costs EXAMPLE- Deductible Temporary Difference Cash B 100 i) accumulated depreciation differs from cumulative tax depreciation Accrual B 100 as depreciation may be accelerated for accounting purposes. Current tax (reduction) @ 20% B 20 Accumulated depreciation is 150 but cumulative tax depreciation is Deferred tax asset B 20 100. Cost and tax income recognition -period I/B DR CR 2 Depreciation I 100 Accumulated depreciation B 100 EXAMPLE- Deductible Temporary Difference Current tax (reduction) 50 @ 20% B 10 iii) an impairment loss recorded for accounting purposes will not Tax income I 24 affect the current tax liability until disposal of the property. Deferred tax asset B 10 I/B DR CR Depreciation and lower tax credit Impairment of property I 10m -period 1 Accumulated depreciation of property B 10m Depreciation I 100 Tax income (deferred tax) @ 20% I 2m Accumulated depreciation B 100 Deferred tax asset B 2m Current tax (reduction) 150 @ 20% B 30 Recording impairment charge and Tax income I 20 (deferred) tax charge 25 www.banks2ifrs.ru EXAMPLES- Deferred tax on share options EXAMPLE- Deductible Temporary Difference 1. E plc has granted share options to key employees both before iv) research costs are expensed in the period for accounting and after 7 November 2002. On adoption of IFRS 2, Share-based purposes, but may only be deducted in a later period for tax Payment, E plc is not opting to apply the standard fully purposes. retrospectively so no expense will be recognised in the income I/B DR CR statement in respect of those share awards granted before 7 Research cost I 10m November 2002. Cash B 10m Tax income (deferred tax) @ 20% I 2m Under UK tax legislation, a tax deduction, equal to the intrinsic Deferred tax asset B 2m value of the options at exercise date, will be available to E plc when Research cost and deferred tax asset the employees exercise their options and receive the shares. -period 1 Current tax liability (reduction) B 2m Does this give rise to a deferred tax asset during the period Deferred tax asset B 2m between the options being granted and exercised? If the amount of Tax income -later period that deferred tax asset changes in the future, will the change be recognised in profit or loss or directly in equity? EXAMPLE- Deductible Temporary Difference v) the recognition of income is deferred for accounting purposes, IAS 12 requires deferred tax to be recognised on all temporary but may be included in taxable profit in the current period. differences. That is, the difference between the tax base and the I/B DR CR accounting carrying amount of assets and liabilities. Cash B 500 In respect of the options granted after 7 November 2002, a Deferred revenue B 500 temporary difference arises between the tax base of the share Deferred tax asset @ 20% B 100 option that has been recognised in the income statement (based on Current tax liability B 100 the future tax deductions) and its carrying value in the balance Receipt of cash and tax payment -period 1 sheet (nil because the IFRS 2 share-based payment expense is Deferred revenue B 500 offset by a corresponding credit entry in retained earnings). This Revenue I 500 gives rise to a deferred tax asset. Tax expense (deferred tax) @ 20% I 100 Deferred tax asset B 100 Similarly, a deferred tax asset will arise in respect of the options Revenue and tax expense recognition granted before 7 November 2002. -period 2 The tax base of these options, like those granted more recently, is

26 www.banks2ifrs.ru based provided by the tax authorities. Since no service has been provided on the future tax deductions. The carrying value of the options in when the year-end financial statements are the balance sheet is, again, nil because there is no share-based drawn up, entity A records no expense in terms of IFRS 2. payment expense. Should entity A recognise deferred tax in respect of the award in its On first-time adoption of IFRS, the credit entry in respect of this year-end financial statements? deferred tax asset will be recognised in equity. There are no recognised assets or liabilities in the accounts of entity The tax deduction will, on exercise of the option, be equal to the A in respect of this award. The initial recognition exemption intrinsic value of the options at the exercise date, which cannot be however does not apply since the taxable profit has been affected known for certain until the date of exercise. Therefore, the tax base by this transaction (para 22(b) of IAS 12). (that is, the amount of the tax deduction to be obtained in the future) should be estimated on the basis of the information available at the This situation is analogous to example 5 of Appendix B in IAS 12. In end of the period (the entity’s share price at the balance sheet that example, the tax authorities provide the company with a tax date). deduction after the IFRS 2 expense is recorded.

At each balance sheet date, the deferred tax asset will be re- There is no recognised asset or liability in that example either, yet a estimated on the basis of information available at that time and the deferred tax asset is recognised since, in the future, the company movements in the asset recognised in profit or loss for share will pay less tax than it should based on its accounting profit. options granted after 7 November 2002 (except to the extent that the deferred tax exceeds the total IFRS 2 charge, in which case Entity A should therefore recognise a deferred tax liability in its movements are recognised in equity) and in equity for share options 2007 financial statements. This treatment is confirmed in para 314 granted before that date. of the basis of conclusion to IFRS 2. 2. Deferred tax on share-based payments Taxable and deductible temporary differences arise where the Entity A is resident in a country where equity-settled share-based accounting measurement of assets and liabilities differs from payments are deductible for tax purposes. The tax authorities allow the tax basis. the entire tax deduction on the grant date of the award. 7 Fair Value Adjustments Entity A grants an equity-settled share-based payment award to its Differences arising from fair value adjustments, whether on employees on the last day of its 2007 financial year. The award acquisition or otherwise, are treated the same as any other vests in three years’ time. On grant date, the full tax deduction is taxable and deductible differences.

27 www.banks2ifrs.ru In simple terms, sales generally generate a tax charge. 10% would be payable on the excess of sales price over cost. Revaluations (fair value adjustments) generate a deferred tax charge (an accrual for tax). How much deferred tax (if any) should the entity recognise at the Differences arising from fair value adjustments examples: balance sheet date?

EXAMPLE - Fair Value Adjustments The principle in IAS 12 is that an entity should recognise deferred i) financial instruments are carried at fair value, but no matching tax based on the expected manner of recovery of an asset, or revaluation may be made for tax purposes. liability, at the balance sheet date. I/B DR CR Financial instrument B 100 The dividends are expected to be derived from the investee’s future Gain – fair value adjustment I 100 earnings rather than from its existing resources at the balance sheet date. Given that there is no impairment expectation arising Tax expense (deferred tax) @ 20% I 20 from the dividends, the entity does not expect the carrying amount Deferred tax liability B 20 at the balance sheet date to be recovered through future dividends Revaluation of financial instrument but rather through sale.

This is important since the expected manner of recovery will determine the deferred tax treatment.

EXAMPLE - Deferred tax on available-for-sale equity The carrying amount of £1,000 has a corresponding tax base of investments £500 on sale. There is a taxable temporary difference of £500 at the balance sheet date. The applicable tax rate is the capital gains rate An entity holds an available-for-sale investment, ie, shares in a of 10%. The entity should recognise a deferred tax liability of £50 listed company. The tax base of the shares is £500, which was the relating to the shares. amount initially paid for the shares. EXAMPLE - Fair Value Adjustments The fair value of the shares at the year end is £1,000. At the ii) revaluation of property, plant and equipment (IAS 16) to fair balance sheet date, the entity expects to sell the shares in five value, but no adjustment for is allowed for tax purposes. years and receive dividends of £500 during this five-year period. I/B DR CR Dividends are not expected to impair the carrying amount of the Revaluation of property, plant and equipment B 700 investment when paid. Revaluation reserve-equity B 700 Dividends are non-taxable. Based on the current tax legislation, if Tax expense (deferred tax) @ 20% charged B 140 the shares were sold after five years, capital gains tax at a rate of to equity 28 www.banks2ifrs.ru Deferred tax liability B 140 arising from the revaluation and the deferred tax asset in respect of Revaluation of property the capital losses if they meet the criteria in IAS 12. In other words, there is a legal right to offset the deferred tax assets and liabilities EXAMPLE - Recognition of capital losses and they relate to the same taxation authority.

Entity F (a UK company subject to UK tax) has a portfolio of As long as these criteria are met, there is no requirement to properties and has capital tax losses arising from that portfolio. In schedule the reversal of the temporary differences to ensure that the current year, entity F has revalued its land and buildings the timing matches. resulting in a (capital gains tax) deferred tax liability being recognised in respect of land and buildings. On acquisition, assets of the company purchased should be fair valued. This will reflect their market value rather than their book Entity F does not expect to realise the capital gain arising from the value. These values will be used in the consolidated accounts. revaluation for a number of years. Is entity F required to recognise a deferred tax asset now in respect of the capital losses under IAS Normally any change in value will not immediately create a tax 12? charge or tax credit. Deferred tax should reflect the value change. Revaluations (fair value adjustments) generate a IAS 12 uses the word shall when it states that deferred tax assets deferred tax charge (an accrual for tax).The net difference will shall be recognised for all deductible temporary differences to the increase or decrease goodwill. extent that taxable profit will be available against which the deductible temporary difference can be utilised. EXAMPLE - Fair Value Adjustments iii) fair value of assets and liabilities on acquisition, does not affect Entity F is required, therefore, to recognise a deferred tax asset in the current tax in the consolidated accounts until each asset is respect of the capital losses if those losses can properly be utilised realised. against the future crystallisation of the capital gains. I/B DR CR Fair value of property, plant and equipment B 600 The fact that there is no current intention to realise the capital gain Inventory – fair value provision B 75 through the sale of the properties does not affect the recognition of Accounts receivable – fair value provision B 25 the deferred tax liability. The difference between the tax base, which remains the same despite the revaluation, and the revalued Goodwill B 400 carrying amount of the asset, is a temporary difference that gives Deferred tax liability (600-75-25) @20% B 100 rise to a deferred tax liability. Fair valuing assets after acquisition

Entity F should offset the presentation of the deferred tax liability

29 www.banks2ifrs.ru Temporary differences will arise from consolidation when the Cost of sales-Intra-group purchases I 5000 carrying amount of an item in the consolidated financial Cost of sales-reduction of intra-group profit I 400 statements differs from its tax base. The tax base is often based Inventory B 400 on the carrying values and tax charges of the individual group Deferred tax asset B 80 members. Tax income (deferred tax) @ 20% B 80

Temporary differences will arise from consolidation examples: Provision against loss of investment I 300 Investment B 300 (In consolidated accounts, profits that have been generated from moving inventory from one unit to another are eliminated, Deferred tax asset B 60 unless the inventory has left the group. This removes unrealised Tax income (deferred tax) @ 20% I 60 profits.) Intra-group transactions eliminated on consolidation

EXAMPLE – Consolidation ii) the retained earnings of controlled undertakings are included in consolidated retained earnings, but taxes are paid on profits when distributed to the parent. I/B DR CR Net assets of subsidiary B 4000 Profits/retained earnings I/B 4000 Deferred tax liability B 800 Tax expense (deferred tax) @ 20% I 800 Retained earnings of controlled undertakings included in consolidated retained earnings EXAMPLE – Consolidation iii) investments in foreign undertakings that are affected by changes EXAMPLE – Consolidation in foreign exchange rates. The carrying amounts of assets and i) unrealised profits resulting from intra-group transactions are liabilities are restated for accounting purposes for changes in eliminated on consolidation but not from the tax base. exchange rates, but no similar adjustment is made for tax purposes. I/B DR CR (See IAS 21.) Revenue-Intra-group sales I 5000 I/B DR CR

30 www.banks2ifrs.ru Net assets of subsidiary B 6000 No, deferred tax should be recognised in the parent’s separate Foreign currency gain - equity B 6000 financial statements in respect of the temporary difference between Deferred tax liability B 1200 the book value of the loan and the tax base of the loan. This is Tax expense (deferred tax) @ 20% -equity B 1200 because IAS 12 does not permit the recognition of deferred tax by a Foreign currency gain of controlled parent in respect of investments in subsidiaries provided certain undertakings included in consolidated conditions are met. retained earnings The conditions are: EXAMPLE – Deferred tax on subsidiary loan a) for taxable temporary differences that the parent can control the timing of the reversal of the temporary difference; and it Entity C, a French entity with a euro functional currency, has a is probable that the temporary difference will not reverse in Russian subsidiary, entity D, with a rouble functional currency. the foreseeable future. Entity C has made a US dollar loan to entity D, which qualifies as b) for deductible temporary differences, it is not probable that part of C’s net investment (quasi-capital) in D in accordance with the temporary difference will reverse in the foreseeable IAS 21. future; and that there will be taxable profit against which the deductible temporary difference can be utilised. A temporary difference exists between the book value and the tax base of the loan for the parent, C, and the subsidiary, D. There also Similarly, no deferred tax is recognised in the consolidated financial exists a temporary difference in respect of the loan on statements. The exceptions provided by IAS 12 apply in the consolidation. consolidated financial statements provided the conditions set out above are met. The book value of the loan is nil on consolidation because the amount receivable by the parent eliminates against the amount However, deferred tax should be recognised in the separate payable by the subsidiary. financial statements of the subsidiary in respect of the temporary difference that arises on the loan from the parent. The exceptions in However, the tax base of the parent’s loan receivable and the tax IAS 12 only apply for investments of investors and not for base of the subsidiary’s loan payable are not eliminated because corresponding loans payable by the investees. they relate to different tax jurisdictions and are of different values. EXAMPLE –Deferred tax- sales to associates Management is considering the accounting for the temporary differences and deferred tax in the parent’s separate financial Entity A has a 31 December year end. A acquired a 40% interest in statements, in the subsidiary’s separate financial statements and in an associate, entity B, on 31 December 20X5 for 500,000. On the the consolidated financial statements. same date, A sold goods costing 60,000 to B for 70,000. B still holds all these goods in inventory at the year-end.

31 www.banks2ifrs.ru Entity B did not earn any profits on 31 December 20X5 so there is The temporary difference relates to A’s asset (its investment in B). It no share of B.s profits for A to is therefore A’s tax rate that is used to calculate the deferred recognise when applying equity accounting. tax.The temporary difference is calculated in accordance with IAS 12 as: However, A recognises an adjustment in its consolidated financial statements to eliminate its share of the unrealised profit of 10,000 Accounting base of investment in B (500,000 - 4,000) 496,000 arising on the sale of inventory to B. Tax base of investment in B 500,000 This consolidation adjustment is: Deductible temporary difference 4,000

Dr: Share of results of associates (40% x 10,000) 4,000 Deferred tax asset (4,000 x 40%) 1,600 Cr: Investment in associate 4,000

B will probably sell the inventory in the next 12 months. If so, the EXAMPLE –Accounting for a tax revaluation deductible temporary difference associated with the unrealised Entity B operates in country X. B has undertaken a group profit will reverse in the next 12 months. restructuring during the current year and as a consequence the tax authorities have allowed a revaluation of the fixed assets to market Entities A and B reside in different tax jurisdictions and pay income value at the date of the reorganisation for tax purposes. tax at 40% and 30% respectively. However, the reorganisation is not a business combination for IFRS What deferred tax adjustments should A’s management recognise purposes and so there has been no change in the IFRS carrying in respect of the inventory sold by A to B? value of the fixed assets. Consequently the tax base on all the fixed assets concerned has Entity A should recognise a deferred tax asset of 1,600, provided it increased and is now higher than the IFRS book values. is probable that it will have taxable profits against which to utilise this deferred tax. How should entity B account for this change in tax values of the fixed assets in its consolidated financial statements? The adjustment to eliminate A’s share of the unrealised profit on sale of inventory to B creates a temporary difference in respect of The differences between the IFRS book values for the fixed assets the carrying amount of A’s investment in B in A’s consolidated and the tax values represent temporary differences. financial statements.

32 www.banks2ifrs.ru The temporary differences will potentially result in the recognition of When preparing the transition balance sheet at 1 January 2004, deferred tax assets. B should therefore assess whether it is should entity B apply the initial recognition exemption when probable that the deferred tax calculating the deferred tax: assets will be recovered and recognise them to the extent that it is probable. (a) to PPE purchased directly by the group; The recognition of the deferred tax assets will result in the recognition of deferred tax income in the income statement. (b) to PPE acquired in a business combination?

This credit cannot be reported in equity as IAS 12, Income Taxes, (a) Yes, entity B should apply the initial recognition exemption when only allows deferred tax to be recognised in equity if the calculating deferred tax in the transition balance sheet. corresponding IFRS entry was also to equity. This is not the case here as the revaluation was not recognised at all for IFRS The basic principle in IFRS 1, First-time Adoption of IFRS, is the purposes. retrospective application of all IFRSs except where an exemption or exception permits or requires otherwise. Consequently entity B EXAMPLE – Recognition of deferred tax – first-time adoption should not recognise deferred tax on transition in respect of that portion of the temporary difference that arose on initial recognition Entity B, a manufacturing entity, is adopting IFRS for the year of a directly purchased item of PPE. ending 31 December 2005 with a transition date of 1 January 2004. (b) The initial recognition exemption does not apply to assets and Entity B operates in a country where the government provides tax liabilities acquired in a business combination. Consequently incentives to invest in property, plant and equipment (PPE) in deferred tax is calculated on transition on the full temporary certain sectors of the economy by providing additional tax difference between accounting base and tax base for PPE originally deductions for the cost of the PPE. acquired in a business combination.

For example, an item of plant and machinery which cost 100 This includes business combinations where the IFRS 1 business qualifies for tax deductions (capital allowances) of 130.The combinations exemption is applied due to the requirement of IFRS additional tax deduction of 30 (130 - 100) represents a temporary 1 that the measurement of deferred tax should follow from the difference that arises on initial recognition of the asset. measurement of other assets and liabilities. The guidance IAS 12 requires that no deferred tax is recognised in Not all temporary differences are recognised as deferred tax respect of the temporary difference that arises on initial recognition balances. of the PPE except when the asset concerned is acquired in a business combination (the initial recognition exemption.). The exceptions are: i) goodwill and negative goodwill; 33 www.banks2ifrs.ru Certain IFRSs permit assets to be carried at a fair value or to be ii) initial recognition of certain assets and liabilities; and revalued: - if the revaluation of the asset is also reflected in the tax base iii) certain investments. then no temporary difference arises. - if the revaluation does not affect the tax base then a temporary Goodwill difference does arise and deferred tax must be provided.

Goodwill is the residual amount after deducting assets and Negative Goodwill liabilities at fair value from the purchase price in an acquisition. IAS 12 does not permit the recognition of a deferred tax asset IFRS do not permit the recognition of a deferred tax liability for arising from deductible temporary differences associated with goodwill when its amortisation/impairment is not deductible. (If negative goodwill, which is treated immediately as income (see it is fully deductible, there is no timing difference, so no deferred IFRS 3). tax arises.) Since March 2004, goodwill can no longer be amortised under IFRS (see IFRS 3 workbook). It is therefore a permanent difference (see above) and deferred tax does NOT apply. A deferred tax liability in respect of goodwill is not permitted, because it would increase the value of goodwill. Initial recognition of certain assets and liabilities

Generally, goodwill is a group accounting concept. In most The second exception relates to a temporary difference that countries, it is the individual companies that are taxed, not the arises from the initial recognition of an asset or liability (other group. It is quite rare for goodwill (and its amortisation or than from a business combination) and affects neither impairment) to be items that attract tax relief. accounting income nor taxable profit.

Where authorities do tax a business combination, deferred tax This exception will apply in limited circumstances, such as: may arise. If an item (income or expense) is not taxable, it should be i) assets for which no deductions are available for tax purposes excluded from the calculations as a permanent difference (see and will be recovered through use. For example, some tax above). authorities do not tax the gain or loss on disposal of an equity investment; the tax base of such an investment is therefore Taxable temporary differences also arise in the following zero; and situations:

34 www.banks2ifrs.ru ii) assets which have a tax base that is different from the cost base at acquisition. For example, an asset which attracts an ii) deferred tax assets should not be recorded if the temporary investment tax credit. differences are expected to continue to exist in the foreseeable future. This may also apply when a non-taxable government grant EXAMPLE-Control of timing of dividends related to an asset is deducted in arriving at the carrying These conditions may be met where a parent has control over amount of the asset but, for tax purposes, is not deducted from a subsidiary's dividend policy and has decided that its tax base; the carrying amount of the asset is less than its tax undistributed profits will not be distributed in the foreseeable base, and this gives rise to a deductible temporary difference. future.

Government grants may also be set up as deferred income (see Investors should usually record deferred tax liabilities for IAS 20), in which case the difference between the deferred associates and joint ventures, unless there is an agreement income, and its tax base of nil, is a deductible temporary between the parties that profits will not be distributed in the difference. Whichever method of presentation an undertaking foreseeable future. adopts, the undertaking does not record the resulting deferred EXAMPLE-Associate tax asset. You have a 40% share of a company. It has been agreed that dividends will be paid annually, if cash is available. Deferred This exception does not apply to a compound financial tax should be calculated for any timing differences. instrument that is recognised as both debt and equity.

The deferred tax impact of the temporary difference on the debt This reflects the tax that would be paid in the parent undertaking component is recognised as part of the carrying amount of the if dividends are received from group companies, especially equity component. foreign investments.

Certain investments The assumption is that the profits made by these investments will be paid to the parent, and that deferred tax needs to be Undertakings should recognise deferred tax assets or liabilities provided. for investments in subsidiaries, associates and joint ventures except in the following situations: To avoid providing deferred tax, the parent must show that such dividends will not be paid. i) deferred tax liabilities should not be recorded where the parent (or investor) is able to control the timing of the reversal of 8 Deferred Tax Assets the temporary difference, and it is probable that the temporary difference will not reverse in the foreseeable future; and Deferred tax assets arising from deductible temporary 35 www.banks2ifrs.ru differences must be reviewed to determine to what extent they Deferred tax asset B 10m should be recognised. The realisation of deferred tax assets Tax income I 10m depends on taxable profits being available in the future. Creation of deferred tax asset from a EXAMPLE-Unusable deferred tax assets tax loss You have a deferred tax asset of $1m. The firm is continually ii) Future taxable profits: the undertaking may recognise a generating losses, and the directors decide to liquidate the firm over deferred tax asset where it anticipates sufficient future taxable the next two years. Further losses are anticipated in the next two profits. years. iii) Tax-planning activities: undertakings commonly engage in The deferred tax asset should be written off, unless there is a tax-planning activities to use tax assets. realistic method to transfer it to another firm that can use it. Tax-planning activities manage taxable profit so that existing tax I/B DR CR Deferred tax asset B 1m losses and credits do not expire. Tax-planning activities usually Tax expense I 1m Write off of deferred tax asset attempt to move taxable profit between periods to use credits

Taxable profits (on which tax will be paid) arise from three and losses. sources: i) Existing taxable temporary differences: taxable temporary Tax-planning opportunities should be considered in determining differences exist relating to the same tax authority and the same taxable undertaking. whether recognition of a deferred tax asset is appropriate. They

To qualify as a deferred tax asset, these differences should should not however be used as a basis for reducing a deferred reverse in the same period as the expected reversal of the deductible temporary difference; or in the periods into which a tax liability until it is settled. tax loss arising from a deferred tax asset can be carried back or forward. Unused tax losses and credits EXAMPLE-Usable deferred tax assets You have a tax loss of $10m. The firm will have a tax liability next An undertaking may record a deferred tax asset arising from year from a taxable temporary difference of $15m. A deferred tax unused tax losses (or credits) when it is probable that future asset should be recorded, as it will reduce next year’s payment. I/B DR CR 36 www.banks2ifrs.ru taxable profit will be available against which the unused losses a deferred tax asset in respect of the losses. The losses carried (and credits) may be utilised. forward at 31 March 20X3 were 3,060,000.

Tax losses, however, may indicate that future taxable profit will Management signed a new 3-year contract with a major customer not be available. This would be the case if the undertaking is during the second quarter of 20X3.The contract provided a continually trading at a loss. significant increase in plant utilisation. Management revised their Outstanding sales contracts and a strong earnings history, profit forecasts based on this new contract and predict that the exclusive of a loss (for example from the sale of an unprofitable tax losses will be fully utilised in 24 months. operation), may provide evidence of future taxable profit. Management therefore have a valid basis for recognising a EXAMPLE - Interim financial statements - change in estimate deferred tax asset for the whole of the tax losses carried forward in the second quarter interim financial statements. Issue Income tax expense is recognised in each interim period based Solution on the best estimate of the weighted average annual income tax Management should recognise a deferred tax asset for the whole rate expected for the full financial year. Amounts accrued for of the tax losses carried forward, with the corresponding deferred income tax expense in one interim period may have to be tax credit recognised in the second quarter income statement. adjusted in a subsequent interim period of that financial year if the estimate of the annual income tax rate changes [IAS34]. The event that has caused the recognition of the deferred tax asset is the signing of the contract in the second quarter. How should management account for the change in interim tax Recognition of the deferred tax in the second quarter is estimates in the subsequent financial statements? appropriate even though the income to be generated from the contract will not be earned until future quarters. Background The undertaking should record a deferred tax asset only to the Entity A has unused tax losses carried forward at 31 December extent that it has sufficient taxable temporary differences to 20X2 of 3,000,000. A’s management did not recognise a deferred match it, or where there is strong evidence that sufficient tax asset in the 20X2 annual financial statements because of taxable profit will be available. uncertainties regarding the utilisation of those losses. Forecasts showed no expected taxable profits for the next three years. EXAMPLE - Deferred tax assets for losses

Management took the same view in the first quarter of 20X3 after Entity C has significant tax losses, having made trading losses for incurring further losses. Management therefore did not recognise the last two years and is considering how much of this can be

37 www.banks2ifrs.ru recognised as a deferred tax asset. The budgets and forecasts for than not in each year prior to expiry of the tax the next five years show a return to profitability in year four. losses. This may result in lower estimates for years in the distant future, but it does not mean that those years should not be What factors should be taken into account when determining considered. whether a deferred tax asset can be recognised? Care should also be taken to ensure that the projections on which IAS 12 does not specify a time period in which recognised tax such assessments are made are consistent with other losses should be recovered. Therefore, there should be no arbitrary communications made by management and with the assumptions cut-off in the time made about the future in relation to other aspects of financial horizon over which an assessment of recoverability is made, accounting (eg, impairment testing), except where relevant whether or not budget information is available after a certain period. standards require a different treatment (eg, impairment testing must not take account of future investment). Only if it is not probable that future taxable profit will be available at all is a deferred tax asset not recognised. Otherwise, a deferred tax In addition, in such circumstances, consideration should be given to asset is recognised to the extent it is considered probable there will the disclosures about key sources of uncertainty required by IAS 1, be future taxable profits. Presentation of Financial Statements.

Where an entity has a history of recent losses, it recognises a deferred tax asset EXAMPLE - Portfolio provision - deferred tax only where there are sufficient taxable temporary differences or where there is convincing other evidence that there will be future Issue taxable profits; such a history A deferred tax asset should be recognised for all deductible may be strong evidence that future taxable profit will not be temporary differences to the extent that it is probable that taxable available. profit will be available against which the deductible temporary difference can be utilised, unless certain limited exceptions apply. It may be that the probability of taxable profits decreases the further into the future we look, but any such assessment should be based Should a bank’s management calculate a deferred tax asset on on the facts. In some cases, it may be clear that no taxable profits the allowance for loan impairment determined on a portfolio are probable after a specific time, for example, where significant basis? contracts or patent rights terminate at a specific date. Background In other cases, the assessment should take into account the Bank A calculates its allowance for loan impairment on a portfolio maximum taxable profits that are considered just more probable basis. The approach is applied to sub-portfolios of loans that

38 www.banks2ifrs.ru either have not been identified as individually impaired or are not Can management recognise a deferred tax asset if the entity individually significant. Impairment and uncollectibility are does not have a track record of profit generation? measured and recognised in the financial statements of the bank in accordance with IFRS 9. Background Management of entity C, a car-making entity, undertakes a A’s management expect the loan portfolio to increase in future reorganisation. The reorganisation involves the transfer of C’s IT years and the amount of the provision is also expected to services department to a separate entity, entity A. increase. Tax relief is obtained only when a specific loan is written off. Management believe that is not likely that the Entity A will have a net deductible temporary difference, because temporary differences will reverse in the medium term, if at all. of the transfer of accrued pension costs related to the employees Solution of the IT department. Yes, management should recognise a deferred tax asset. Management expects A to incur losses for the first year of A’s operations but expects it to become profitable thereafter. The The allowance for loan impairment affects the carrying value of forecast future profit is based on sales to third parties using the loan portfolio and accounting profit. There is no adjustment to existing business processes. the tax base of any loans. Consequently, a deductible temporary difference exists between the tax base of the loan portfolio and its Solution carrying value. Deferred tax should be recognised on this Management should not recognise a deferred tax asset. temporary difference. A’s performance will depend on sales to third parties, with which The undertaking must also consider the time limits for which tax management is not experienced. Management should therefore authorities permit such losses and credits to be carried forward, not recognise the deferred tax asset because it is not probable in assessing recoverability. that taxable profits will be available.

EXAMPLE - Deferred tax asset on deductible temporary 9 Determine appropriate tax rates differences based on a business plan Deferred tax assets and liabilities should be measured at the tax rates expected to apply to the period when the asset or liability Issue is liquidated. When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, a deferred tax asset is recognised to the extent that taxable profit will be available.

39 www.banks2ifrs.ru EXAMPLE-Tax rates

You have a taxable temporary difference of $200m. The rate of income tax is 20%. Although there are rumours that the rate for future years will be lower, no official announcement has yet been made. The current rate must be used.

The deferred tax liability will be $200m * 20% = $48m.

I/B DR CR Deferred tax liability B 40m Tax expense – deferred tax I 40m Creation of a deferred tax liability The best estimate of the tax rate that will apply in the future is the tax rates that have been enacted (or ‘substantively enacted’) at the balance sheet date.

Tax rates have been ‘substantively enacted’ when draft legislation is nearing the end of the approval process.

When different rates of tax apply to different types and amounts of taxable income, an average rate is used.

40 www.banks2ifrs.ru EXAMPLE - Use of average rate

Issue Deferred tax assets and liabilities are measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in which the temporary differences are expected to reverse, when different tax rates apply to different levels of taxable income [IAS12R.49].

Can management use one tax rate for a specific temporary difference and a different, average, tax rate for the remaining temporary differences, when graduated tax rates apply?

Background Entity A operates in a country where different rates apply to different levels of taxable income.

At 31 December 20X3 the net deductible temporary differences total 30,000. Management expects the temporary differences to reverse over the next seven years. The average projected profit for the next seven years is 60,000.

A deductible temporary difference related to impairment of trade receivables of 25,000 is expected to fully reverse in 20X5, when the related expense will be deductible for tax purposes.

Solution Yes, management should consider separately the impact of this temporary difference reversing in a single year.

The reversal of this large temporary difference will cause a distortion in the average statutory tax rate. Management should therefore consider its effect separately when calculating the average statutory rate to be used for deferred tax assets and liabilities.

The following table illustrates how management may calculate the deferred tax assets and liabilities, assuming certain graduated tax rates: Average Year 2005 Range Tax rate Profit Income tax Profit Income tax - 1,000 18% 1,000 180 1,000 180

1,001 10,000 25% 10,000 2,500 10,000 2,500

41 www.banks2ifrs.ru 10,001 25,000 30% 25,000 7,500 24,000 7,200 25,001 50,000 40% 24,000 9,600

60,000 19,780 35,000 (a) 9,880

Average rate 33% 28%

(a) Average profit - temporary difference (60,000 - 25,000 = 35,000) Management should apply a tax rate of 28% for the deferred tax asset related to impairment of trade receivables, and 33% for the remaining temporary differences.

Deferred tax assets and liabilities must not be measured on a The measurement of a deferred tax asset or liability should discounted basis. reflect the way the undertaking expects to liquidate the asset's carrying value or the liability. EXAMPLE - Applicable tax rate for reconciliation between tax expense and accounting profit when there are several For example, if the undertaking expects to sell an investment domestic income-based taxes and the transaction is subject only to capital gains tax, the undertaking should measure the related deferred tax liability at Issue the tax rate applicable to capital gains, if different from the Management must explain the relationship between tax expense income tax rate. (income) and accounting profit. This may be a numerical reconciliation between actual and expected tax expense (income) Profits may be taxed at different rates depending on whether or between the average effective tax rate and the applicable tax they are distributed to shareholders. An undertaking should rate. measure deferred tax assets and liabilities using the tax rates applicable to undistributed profits. The applicable tax rate that provides the most meaningful information to the users of the financial statements should be used. When a dividend is subsequently declared and recorded in the financial statements, the undertaking should recognise the What tax rates should management include in the applicable tax dividend's tax consequences to the undertaking (if any). rate when an entity operates under a tax regime levying more than one income-based tax? 42 www.banks2ifrs.ru Solution Background Entity G operates in country H in two locations A and B. All entities Management should provide a reconciliation of the expected tax in country H incur three principal taxes; a Federal tax, a Local tax charge rather than the effective tax rate. and a President’s Special tax. G generates profits and incurs tax in regions A and B as follows:

Region A B Total Accounting profit 75,600 19,100 94,700 Taxable profit for 70,350 18,860 Federal and President’s Special tax purposes Taxable profit for 48,600 13,000 Local tax purposes Federal tax rate 25% 25% President’s Special 5.5% 5.5% Tax rate Local tax rate 4% 7%

The source of profits is consistent from year to year, that is G consistently generates approximately 80% of its profits in region A each year.

The taxable profit for local income tax purposes is based on the taxable profit for Federal purposes, less the amount of Federal and President’s Special tax charged plus or minus some additional minor items.

Management propose that only the Federal tax rate of 25% be included in the applicable tax rate.

43 www.banks2ifrs.ru EXAMPLE - Change in tax status effective during the period

Issue The carrying amount of deferred tax assets and liabilities may change even though there is no change in the amount of the related temporary differences. This can result, for example, from a change in tax rates or tax laws.

Can management recognise directly in equity the tax consequences of a change in an entity’s tax status effective during the accounting period?

Background On 31 August 20X2, entity A changed its status from one type of limited company to another. Entity A therefore became subject to a higher income tax rate (30%) than it was previously (25%).

The change in applicable tax rate applies to taxable income generated from 1 September 20X2. The tax rates applicable to a profit on sale of land are also different and amount to 40% compared with 30% previously.

The information below relates to temporary differences that exist at 1 January 20X2 and at 31 December 20X2 (the end of accounting period) and which will all reverse after 1 January 20X3.

Carrying amount Tax base Temporary Carrying amount Tax base Temporary difference difference 01/01/X2 01/01/X2 31/12/X2 31/12/X2 Trade 2,200 2,500 (300) 2,500 2,800 (300) receivables Land (carried 800 500 300 800 500 300 at revalued amount) Plant and 3,000 800 2,200 2,900 600 2,300 machinery Warranty (1,000) 0 (1,000) (1,000) 0 (1,000) provisions

44 www.banks2ifrs.ru Total 5,000 3,800 1,200 5,200 3,900 1,300 Solution

No, the tax consequences of the change in applicable tax rate should be included in net profit or loss for the period, unless they relate to items originally recognised directly in equity.

The deferred tax at the opening and closing balance sheet dates is calculated as follows:

Temporary Deferred tax Temporary Deferred tax difference difference 01/01/X2 31/12/X2 Trade receivables (300) (300) Plant and machinery 2,200 2,300 Warranty provisions (1,000) (1,000) Total 900 225 (900x25%) 1,000 300 (1,000x30%)

Land (carried at revalued amount) 300 90 (300x30%) 300 120 (300x40%)

The change in deferred tax relating to the receivables, the plant and machinery and the warranty provisions is included in the income statement. The change in deferred tax relating to the land is included in equity because the revaluation of the land is included in equity.

Management must disclose the change in the entity’s tax status and the quantification of this change in the notes to the financial statements. rate applicable to undistributed profits. EXAMPLE - Dividends declared after balance sheet date Should management apply the tax rate applicable to distributed profits for the portion of net profit corresponding to dividends Issue declared after the balance sheet date? Income taxes might be payable at a higher or lower rate if part or all of the net profit or retained earnings is paid out as a dividend to an Background entity’s shareholders. Management should, in these circumstances, Management declared in February 20X4 a dividend of 400 payable measure current and deferred tax assets and liabilities at the tax on 31 March 20X4. Management did not recognise a liability for the 45 www.banks2ifrs.ru dividend at 31 December 20X3 in accordance with the requirements Depreciation for the building is over 30 years and is not deductible of IAS 37. for tax purposes. Any gain on the sale of building is not taxable. The profit before tax was 2,000. The tax rate is 30% for The entity carries the building at revalued amount. As at 31 undistributed profits and 40% for distributed profits. December 20X1, the building is revalued at 3,200,000. Tax rate of 30% would apply to other income. Solution No, management should apply the tax rate applicable to Solution undistributed profit. On 1 January 20X1 (date of acquisition)

The recognition of the obligation to pay dividends is the trigger that The temporary differences as at 1 January 20X1 can be measured requires management to use the tax rate for distributed profit. as follows: Management should therefore recognise a current income tax expense of 600 (2,000 x 30%). Carrying amount 3,000,000 (acquisition cost)

During 20X4 management will recognise a liability for dividends Less: future taxable (3,000,000) (future assessable payable of 400. It should also recognise additional tax liability 40 income income should be at (400 x 10%) as a current tax liability and an increase of the current least the carrying income tax expense for 20X4. amount)

Zero capital gains tax Add: future deductible - Depreciation is not Issue amounts deductible The measurement of deferred tax liabilities and deferred tax assets should reflect the tax consequences that would follow from the way in which management expects to recover or settle the Tax base - underlying asset or liability [IAS12R.51]. Carrying amount 3,000,000 How would this affect the calculation of deferred tax of an entity that does not suffer any tax consequences from the gain on sale of an asset? Taxable temporary 3,000,000 differences Background An entity acquired a building on 1 January 20X1 for 3,000,000.

46 www.banks2ifrs.ru There is a taxable temporary difference, but it arises from the initial recognition of the asset and, accordingly, no deferred tax liability is recognised. Taxable temporary Tax Deferred As at 31 December 20X1 (Carrying amount recovered through use differences rate tax of asset) liability

As at the end of the financial year, the entity intends to recover the Initial recognition * 2,900,000 - - building’s carrying amount through the use of the building. The temporary differences as at 31 December 20X1 can be measured (3,000,000- as follows: 100,000) Revalued amount** 300,000 30% 90,000 Carrying amount 3,200,000 (revalued amount) 3,200,000 90,000 Less: future taxable (3,200,000) (future assessable income should be at income *: Taxable temporary differences arise from the initial recognition least the carrying and accordingly no deferred tax liability is provided amount) **: Taxable temporary differences arise from subsequent recognition of the increase in the building’s value. The Add: future deductible - Depreciation is not subsequent increase will be recovered through the use of the amounts deductible building, which will generate profit from operation that is taxable at 30%. The tax rate applicable therefore would be 30%, and a deferred tax liability would be recognised. The corresponding entry is to equity because the underlying revaluation is Tax base - recognised in equity. Carrying amount 3,200,000 As at 31 December 20X1 (Carrying amount recovered through the sale of asset)

Taxable temporary 3,200,000 As at the end of the financial year, the entity intends to recover the differences building’s carrying amount by selling it. The entity has entered into a binding agreement to sell the building before the end of the financial year. The temporary differences as at 31 December 20X1 can be

47 www.banks2ifrs.ru measured as follows: *: Taxable temporary difference arising from the sale of the building, Carrying amount 3,200,000 (revalued amount) which is taxable at a rate of 0%.

Less: future taxable (3,200,000) (future assessable income income should be at 10 Determine movement in deferred tax balances least the carrying The movements in deferred tax assets and liabilities should be amount) recorded: -either as deferred tax expense/credit in the income statement; -or in equity, for those transactions for which the tax effects are Add: future deductible 3,000,000 Initial cost is recognised in equity. amounts deductible on sale EXAMPLE-Tax rates changes

Tax base 3,000,000 You have a temporary taxable difference of $200m. The rate of income tax is 24%.

In the next period, an official announcement is made that the Carrying amount 3,200,000 income tax rate will fall to 20%.

The deferred tax liability will be reduced to $200m * 20% = $40m. Taxable temporary 200,000 (This example assumes that all of the deferred tax relates to the differences income statement.) I/B DR CR Deferred tax liability B 48m Tax expense – deferred tax I 48m Creation of a deferred tax liability Taxable temporary Tax Deferred Deferred tax liability B 8m differences rate tax liability Tax income (or reduction of tax expense) – I 8m deferred tax Proceeds in excess of 200,000 0% Change of rate of deferred liability cost* 0 Subsequent recognition 48 www.banks2ifrs.ru At each balance sheet date, an undertaking should review Similarly, an acquiree may have an unrecorded deferred tax unrecorded deferred tax assets to determine whether new asset relating to tax losses. Subsequent to acquisition, these conditions will permit the recovery of the asset. losses are recoverable through utilisation of future taxable profit generated by the acquired group. EXAMPLE-Unrecognised deferred tax asset (This scenario assumes that the tax losses are not cancelled by Your firm has been making losses, and has generated tax the change in ownership of the acquiree.) losses of $50m. These were not shown on the balance sheet as no trading improvement was anticipated. Subsequent measurement

A Japanese company signs contracts to use your The carrying amount of deferred tax assets and liabilities will components in its new factory, which will return your firm to change in subsequent periods with the recognition and profit. reduction of temporary differences.

You decide that you will be able to use the carried-forward The carrying amount of a deferred tax asset should be reviewed losses before they expire. You recognise these losses as a at each balance sheet date for: deferred tax asset. i) changes in tax rates; The deferred tax asset will be $50m * 20% = $10m. ii) changes in the expected manner of recovery of an asset; I/B DR CR Deferred tax asset B 10m iii) changes in future profits. Tax income – deferred tax I 10m Creation of a deferred tax asset

For example, an acquirer in a business combination may not have recorded a deferred tax asset in respect of tax losses.

Subsequently, the acquired undertaking may however generate sufficient taxable profit to absorb these losses and permit recognition in the consolidated financial statements.

49 www.banks2ifrs.ru EXAMPLE- Changes in future profits current tax liabilities and assets, and alter its deferred tax assets or liabilities. Your firm has been making losses, and has generated tax losses of $50m. These were not shown on the balance sheet EXAMPLES –Change of tax status as no trading improvement was anticipated. 1. Your head office is relocated to another country. It adopts the new country’s tax system. A Japanese company signs contracts to use your components 2. Your firm changes its legal status from a company in its new factory, which will return your firm to profit. to a limited partnership, which requires it to adopt tax rules for limited partnerships. You decide that you will be able to use the carried-forward 3. Your firm is bought by another firm. The tax losses before they expire. You recognise these losses as a authorities cancel all brought-forward tax losses due deferred tax asset. The deferred tax asset will be $50m * 20% to the change in ownership. = $10m.

The following year, increased costs indicate that taxable The tax consequences of a change in tax status should be profits will only use $10m of the $50m losses. You reduce the included in tax expense, unless the underlying transaction was deferred tax asset by $40*20% = $8m. recorded in equity.

I/B DR CR Tax assets and liabilities Deferred tax asset B 10m Current and deferred tax assets and liabilities should be Tax income – deferred tax I 10m presented separately on the face of the balance sheet. Creation of a deferred tax asset Tax expense – deferred tax I 8m Deferred tax assets and liabilities should be classified as non- Deferred tax asset B 8m current. Reduction of deferred tax asset due to changes in future profits Offset (netting an asset and a liability) 11 Presentation Current tax assets and liabilities should only be offset when: Change in tax status of an undertaking or its shareholder -an undertaking has a legal right of offset; and A change in the tax status of an undertaking or its shareholder -intends to settle on a net basis, or (parent) may have an immediate impact on the undertaking's -to liquidate the asset and liability simultaneously.

50 www.banks2ifrs.ru The legal right only arises when the same tax authority levies the taxes, and that authority accepts settlement on a net basis. The entity has a right to use the deferred tax asset to offset the deferred tax liabilities so, on the face of the balance sheet, the EXAMPLE-Offset company discloses the net deferred tax liability position of £4.50. Your firm has carry-forward tax losses of $15m that are recorded as a current asset. These were caused by trading losses last year. IAS 12 requires disclosure in the notes to the financial statements in This year you have a tax charge for the year, due to trading profits. respect of each type of temporary difference. The amount of the This is a current liability. When the tax authorities agree that the deferred tax assets and liabilities recognised in the balance sheet loss may be used to reduce the liability, it can be offset. for each period presented. Does this mean that the disclosure in the I/B DR CR notes to the financial statements should show the gross position Tax loss-current asset B 15m (that is, a deferred tax asset of £4.50 and a deferred tax liability of Tax income I 15m £9?) Recording previous year tax loss Tax expense I 40m No. We do not believe that IAS 12 requires a gross presentation Tax liability B 40m because the deferred tax noted in the above table relates to the Recording tax charge for this year same type of temporary difference: that is, differences between Tax liability B 15m depreciation for tax and accounting purposes. Tax loss-current asset B 15m Offsetting carry- forward loss against The company has the right to offset the deferred tax asset and current liability liability (so is presenting the net position in the balance sheet) so the amount of that net position relating to the difference between EXAMPLE- IAS 12 disclosures the carrying amount and tax base of PPE (that is, £4.50) should be disclosed as a component of the total deferred tax liability At the year-end company C, reporting under IFRS, has property, recognised. plant and equipment (PPE) with carrying amounts, tax bases and temporary differences outlined in Table 1.These result from assets Table 1 Class of PPE Carrying Tax base (£) Temporary DT difference being deductible for tax purposes in a manner that differs from the depreciation recognised for accounting purposes. amount asset/(liability) (£) (£) @30% (£) At an effective tax rate of 30%, the PPE in a deferred tax liability Property 100 80 20 -6 position (the property and the office equipment) give rise to a Cars 50 65 -15 4,5 deferred tax liability of £9 and the assets in a deferred tax asset Office equipment 20 10 10 -3 position give rise to a deferred tax asset of £4.50. 51 www.banks2ifrs.ru Tax assets in consolidated financial statements of one group base of the asset is adjusted, and no temporary difference member may only be offset against a tax liability of another arises. member if there is a right to offset and the group intends to settle on a net basis, or to liquidate the asset and liability EXAMPLE-Revaluation of asset that is taxed simultaneously. Your group wishes to revalue its balance sheet prior to a public listing. Its subsidiary will suffer current tax on the revaluation. Similar conditions apply to offsetting deferred tax assets and I/B DR CR liabilities. Deferred tax assets and liabilities in consolidated Property B 200m financial statements relating to different tax jurisdictions should Revaluation reserve B 200m not be offset. Recording property revaluation Tax expense –revaluation reserve B 48m The group's tax planning opportunities are not usually grounds Current tax liability B 48m for offset unless the opportunity relates to income taxes levied Recording current tax charge on the by the same tax authority on different group members, and the equity component undertakings intend to liquidate the tax assets and liabilities on a net basis or simultaneously. In other countries, the revaluation of an asset does not affect taxable profit in the period, and the tax base of the asset is not Tax expense adjusted. Such revaluations require deferred tax to be accrued.

Tax expense (income) related to profit from ordinary activities The future liquidation of the carrying amount will result in a should be presented on the face of the income statement. The taxable flow of benefits to the undertaking, and the amount that main components of the tax expense (income) should also be will be assessed for tax purposes will differ from the amount of disclosed (see Disclosure below). those benefits.

The difference between the carrying amount of a revalued 12 Accounting for Deferred Tax - Detailed Rules asset, and its tax base, is a temporary difference and gives rise Assets Carried at Fair Value to a deferred tax liability, or asset. EXAMPLE-Revaluation of an IAS 16 asset that is not Standards permit certain assets to be carried at fair value, or to subject to current tax. be revalued (for example, IAS 16, IAS 38, IFRS 9, and IAS 40). Your group wishes to revalue its balance sheet prior to a public listing. Its subsidiary will suffer no current tax on the In some countries, the revaluation of an asset to fair value revaluation. affects taxable profit for the current period. As a result, the tax I/B DR CR 52 www.banks2ifrs.ru Property B 300m Entity A conducts its business in country Z. Management has Revaluation reserve B 300m revalued the land on which the entity’s industrial plant is located, Recording property revaluation and has recognised the increase from the revaluation in equity Revaluation reserve - Tax expense B 60m [IAS16R.39]. Deferred tax liability B 60m Recording deferred tax charge on The tax rate applicable to a profit on sale of PPE in Country Z is the equity component 30%, and the tax rate applicable to taxable profits earned from using the asset is 40%. This is true even if: Solution (1) the undertaking does not intend to dispose of the asset. Management should use the tax rate applicable to a profit on sale The revalued carrying amount of the asset will be of the land, that is, 30%, to determine the deferred tax associated recovered through use (for example, depreciation). This with the property. will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in The difference between the revalued amount of the land and its future periods; or tax base is a temporary difference and gives rise to a deferred tax liability [IAS12R.20]. The corresponding deferred tax charge (2) tax on capital gains is deferred, if the proceeds of the should be recognised in equity because the revaluation increase disposal of the asset are reinvested in similar assets. In is recognised in equity. such cases, the tax will become payable on sale (or use) of the similar assets. The land is a non-depreciable asset. The corresponding deferred tax liability that arises from the revaluation is measured based on EXAMPLE - Deferred tax arising from revaluation of land the tax consequences that would follow from recovery of the land’s carrying amount through sale [SIC-21.5]. This is because Issue the revalued amount of the land is not recovered through an A deferred tax liability should be measured at the tax rates that accounting charge such as depreciation. are expected to apply to the period in which the liability is settled [IAS12R.47]. EXAMPLE - Convertible debt Which tax rate should management use for calculating the deferred tax liability in respect of revalued land? Issue

Background The tax base of a liability component of a compound instrument on 53 www.banks2ifrs.ru initial recognition may be equal to the initial carrying amount of the interest charge for accounting purposes will therefore be higher sum of the liability and equity components. The resulting taxable than the cash paid as interest on the bond. temporary difference arises from the initial recognition of the equity component separately from the liability component. A tax deduction will be received for the interest paid in cash. The difference between the interest expense for accounting purposes and the cash amount of interest is not deductible for tax purposes. How should management calculate the deferred tax liability on the The entity is subject to an income tax rate of 40%. taxable temporary difference arising from the initial recognition of Solution a compound instrument? Management should calculate the deferred tax liability as the Background difference between the carrying amount of the liability element and the tax base of the bond. An entity issues a convertible bond on 1 January 20X3 which will mature on 31 December 20X7. The holders of the bond have the right to convert the instrument into a fixed number of the entity’s Carrying amount of the liability component 1,836 ordinary shares at any time. The interest rate of the bond is 5% and is paid annually. The market interest rate is 7%. Tax base of the liability component 2,000 Temporary difference 164 Management calculates the initial amount of the liability and equity components by discounting the future cash flows associated with Deferred tax liability (164 x 40%) 66 the liability element at 7%. Management determines the components as follows: The corresponding entry to the deferred tax liability is to the equity instrument. The equity element will therefore be stated at 98 (164- Liability component 1,836 66). However, the effect of the subsequent changes in the carrying value of the liability component will be reflected as a deferred tax Equity component 164 expense in the income statement.

The following table summarises the effects of the deferred tax Total amount of the bond 2,000 over the period to maturity:

Management will recognise an interest expense for accounting purposes based on 1,836 at the market interest rate of 7%. The 54 www.banks2ifrs.ru 31/12/X7 31/12/X3 31/12/X4 31/12/X5 31/12/X6

100 Nominal 100 100 100 100 interest 1/1/X 31/12/X 31/12/X 31/12/X 31/12/X 31/12/X (5%) 3 3 4 5 6 7 137 Interest 129 131 133 135 Carrying 1,836 1,865 1,895 1928 1,963 2,000 market amount of rate the liability (7%) component

Tax base 2,000 2,000 2,000 2,000 2,000 2,000 of the Difference 29 31 33 35 37 liability component Income tax 12 12 13 14 15 on the Taxable 164 135 105 72 37 - difference temporary (40%) difference Items Credited or Charged Directly to Equity

Deferred tax 66 54 42 29 15 - Current tax and deferred tax should be charged, or credited, liability directly to equity, if the tax relates to items that are credited, or charged, in the same or a different period, directly to equity (see Deferred tax - 12 12 13 14 15 revaluation examples above). expense Standards require or permit certain items to be credited, or charged, directly to equity. Examples of such items are: The deferred tax expense corresponds to the difference between the accounting interest expense and the cash interest expense of the bond. The following table illustrates: (1) a change in carrying amount arising from the revaluation of property, plant and equipment under IAS 16 ;

55 www.banks2ifrs.ru (2) an adjustment to the opening balance of retained earnings, resulting from either a change in accounting Under IAS 16, an undertaking may transfer each period, from policy applied retrospectively, or the correction of an revaluation surplus to retained earnings, an amount equal to: error. IAS 8 has seriously limited this application; the difference between the depreciation (or amortisation) on a revalued asset, and the depreciation (or amortisation) based on (3) exchange differences, arising on the translation of the the cost of that asset. financial statements of a foreign undertaking in (see IAS 16 workbook.) consolidation; and (4) amounts arising on initial recognition of the equity If an undertaking makes such a transfer, the amount transferred component of a compound financial instrument (see is net of any related deferred tax. IFRS 9). Similar considerations apply to transfers made on disposal of an It may be difficult to determine the amount of current and item of property, plant or equipment and any related revaluation deferred tax that relates to items credited, or charged, to equity. surplus. This may be the case when: When an asset is revalued for tax purposes, and that (1) there are graduated rates of income tax, and it is revaluation is related to an accounting revaluation of an earlier impossible to determine the rate at which a specific period, or to a future period, the tax effects of both the asset component of taxable profit (tax loss) has been taxed; revaluation and the adjustment of the tax base are credited (or charged) to equity, in the periods in which they occur. (2) a change in the tax rate or rules, affects a deferred tax asset, or liability, relating to an item that was previously However, if the revaluation for tax purposes is not related to an charged to equity; or accounting revaluation, any tax effects of the adjustment of the tax base are recorded in the income statement. (3) an undertaking determines that a deferred tax asset should be recorded, or should no longer be recorded in Current and deferred tax arising from share-based payment full, and the deferred tax asset relates to an item that transactions was previously charged to equity. An undertaking may receive a tax deduction that relates to In such cases, the current and deferred tax is based on a remuneration paid in shares, share options or other equity reasonable pro-rata allocation of the current, and deferred tax in instruments of the entity. The amount of that tax deduction may the tax jurisdiction concerned, or other method that achieves a differ from the related cumulative remuneration expense, and better allocation in the circumstances. may arise in a later accounting period.

56 www.banks2ifrs.ru Accordingly, if the tax law specifies a tax rate applicable to the For example, an entity may recognise an expense for the taxable amount derived from the sale of an asset that differs salaries paid for in share options granted, in accordance with from the tax rate applicable to the taxable amount derived from IFRS 2 Share-based Payment, and not receive a tax deduction using an asset, the former (sale) rate is applied in measuring until the share options are exercised, with the tax deduction the deferred tax liability or asset related to a non-depreciable based on the entity's share price at the date of exercise. asset.

The difference between the tax base of the employee services In the case of IAS 40, this assumption can be rebutted. received (the amount the taxation authorities will permit as a deduction in future periods), and the carrying amount of nil, is a Other Comprehensive Income deductible temporary difference that results in a deferred tax asset. Deferred tax on revaluation movements listed in Other Comprehensive Income will be included with them in that If the amount of the tax deduction for future periods is not financial statement. The notes will identify the amount of known at the end of the period, it shall be estimated, based on deferred tax relating to each component. information available at the end of the period. 13 Disclosure For example, if the amount that the tax deduction in future periods is dependent upon the undertaking's share price at a (Please also refer to ‘Illustrated Corporate Consolidated future date, the measurement of the deductible temporary Financial Statements’ and ‘Illustrative consolidated difference should be based on the entity's share price at the end financial statements for Banks’ published by of the period. PricewaterhouseCoopers and available on its website. This provides sample notes illustrating some of the disclosures listed Revaluations under IAS 16 + IAS 40 here.)

If a deferred tax liability or deferred tax asset arises from a non- The major components of tax expense (income) should be depreciable asset measured using the revaluation model in IAS disclosed separately. 16 or IAS 40, the measurement of the deferred tax liability or deferred tax asset shall reflect the tax consequences of Components of tax expense (income) may include: recovering the carrying amount of the non-depreciable asset through sale, regardless of the basis of measuring the carrying (1) current tax expense (income); amount of that asset.

57 www.banks2ifrs.ru (2) any adjustments, recorded in the period, for current tax (6) the amount from a previously unrecorded tax loss, tax of prior periods; credit, or temporary difference of a prior period, that is used to reduce deferred tax expense; (3) the amount of deferred tax expense (income) relating to the start, and reversal, of temporary differences; (7) deferred tax expense arising from the write-down, or reversal of a previous write-down, of a deferred tax (4) the amount of deferred tax expense (income) relating to asset; and changes in tax rates, or new taxes; (8) the amount of tax expense (income) relating to those (5) the amount arising from a previously unrecorded tax changes in accounting policies, and errors, which are loss, tax credit, or temporary difference of a prior period, included in the net profit for the period. that is used to reduce current tax expense;

58 www.banks2ifrs.ru Group’s reconciliation between tax expenses and accounting profit when there are several subsidiaries with different tax rates

Issue Management should disclose an explanation of the relationship between tax expense and accounting profit, by presenting a numerical reconciliation either between tax expense and accounting profit or between the average effective tax rate and the applicable tax rate.

How should management present such a reconciliation in a group’s financial statements when there are several subsidiaries with different tax rates?

Background Entity L is incorporated in Luxembourg and is a non-operating holding entity. L has subsidiaries in Italy, Finland and Brazil. The following table provides information for each member of the group in respect of its statutory tax rate and its profit before tax:

Country Statutory tax Profit before tax Tax at Tax at difference Tax charge per rate (A) (B) statutory tax between consolidated rate (AxB) Luxembourg rate financial statements and statutory rate (A-25%)x(B)

Luxembourg 25% 20 5 -

Italy 37% 700 259 84

Finland 29% 400 116 16

Brazil 33% 500 165 40

Total 1,620 545 140 520

Management would prefer to present a reconciliation of monetary amounts rather than a reconciliation of the tax rates. 59 www.banks2ifrs.ru The following should also be disclosed separately: (6) for each type of temporary difference, and for each type of unused tax losses and credits: (1) the total current and deferred tax relating to items that are charged, or credited, to equity; (i) the amount of the deferred tax assets, and liabilities, recorded in the balance sheet for each period (2) an explanation of the relationship between tax expense presented; (income) and accounting profit, in either, or both, of the following forms: (ii) the amount of the deferred tax income, or expense, recorded in the income statement, if this is not (i) a numerical reconciliation between tax expense apparent from the changes in the amounts recorded (income) and the product of accounting profit in the balance sheet; multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (7) in respect of discontinued operations, the tax expense (are) computed, or relating to:

(ii) a numerical reconciliation between the average (i) the gain (or loss) on discontinuance; and effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax (ii) the profit (or loss) from the ordinary activities of the rate is computed; discontinued operation for the period, with the corresponding amounts for each prior period (3) an explanation of changes in the applicable tax rate(s) presented; and compared to the previous accounting period; (8) the income tax consequences of dividends that (4) the amount (and expiry date, if any) of deductible were proposed, or declared, before the financial temporary differences, unused tax losses, and unused statements were approved for issue, but are not tax credits for which no deferred tax asset is recorded in recorded as a liability in the financial statements. the balance sheet; An undertaking should disclose the amount of a deferred tax (5) the total amount of temporary differences associated asset, and the evidence supporting its recognition, when: with investments in subsidiaries, branches and associates, and in joint ventures, for which deferred tax liabilities have not been recorded;

60 www.banks2ifrs.ru (1) the undertaking has suffered a loss, in either the current, Usually the most meaningful rate is the undertaking’s local rate or preceding, period in the tax jurisdiction to which the of tax. deferred tax asset relates; and (2) the utilisation of the deferred tax asset is dependent on For an undertaking operating in several countries, it may be future taxable profits, in excess of the profits arising more meaningful to aggregate separate reconciliations, from the reversal of existing taxable temporary prepared using the domestic rate in each individual jurisdiction. differences. The average effective tax rate is the tax expense (income) In these circumstances, an undertaking should disclose the divided by the accounting profit. nature of the potential tax consequences that would result from the payment of dividends to its shareholders. It would often be impracticable to compute the amount of unrecorded deferred tax liabilities arising from investments in In addition, the undertaking should disclose the amounts of the subsidiaries, branches and associates, and joint ventures. potential tax consequences determinable, and whether there are any potential tax consequences not determinable. Therefore, IAS 12 requires an undertaking to disclose the aggregate amount of the underlying temporary differences. These disclosures enable users to understand whether the relationship between tax expense (income) and accounting Undertakings may also disclose the amounts of the unrecorded profit is unusual, and to understand the factors that could affect deferred tax liabilities, as users may find such information that relationship in the future. useful.

The relationship between tax expense (income), and accounting An undertaking discloses the important features of the income profit may be affected by such factors as: tax systems, and the factors that will affect the amount of the - revenue that is exempt from tax, potential income tax consequences (to the undertaking) of - expenses that are not deductible in determining taxable dividends, if any. profit, - the effect of tax losses, and It may not be practicable to compute the tax consequences - the effect of foreign tax rates. from the payment of dividends to shareholders. This may be the case where an undertaking has a large number of foreign In explaining the relationship between tax expense (income) subsidiaries. and accounting profit, an undertaking uses an applicable tax rate that provides the most meaningful information to the users. However, even in such circumstances, some portions of the total amount may be easily determinable. For example, in a

61 www.banks2ifrs.ru consolidated group, a parent, and some of its subsidiaries, may discloses any significant effect of those changes on its current have paid taxes at a higher rate on undistributed profits, and be and deferred tax assets and liabilities. aware of the amount that would be refunded on the payment of future dividends, from consolidated retained earnings. In this Exchange Differences on Deferred Foreign Tax Liabilities case, that refundable amount is disclosed. or Assets

If applicable, the undertaking also discloses that there are Exchange differences that arise on foreign deferred tax assets additional tax consequences not determinable. and liabilities, may be included as part of the deferred tax expense (income). In the parent's separate financial statements, if any, the disclosure of the tax consequences relates to the parent's A more usual presentation would be to include the exchange retained earnings. differences on deferred taxes as part of the foreign exchange An undertaking, required to provide these disclosures, may also gains and losses (see IAS21). be required to provide disclosures related to temporary Foreign currency-denominated deferred tax assets and liabilities differences, associated with investments in subsidiaries, are non-monetary items that are translated at the closing branches and associates or joint ventures. balance sheet rate, being the date at which they are measured (see IAS21). For example, an undertaking may be required to disclose the aggregate amount of temporary differences associated with investments in subsidiaries, for which no deferred tax liabilities have been recorded. 14 Appendix – Some IFRS / Russian Accounting If it is impracticable to compute the amounts of unrecorded Comparisons. deferred tax liabilities, there may be tax consequences of dividends not determinable, related to these subsidiaries. This document was written based on the assumption that the client will undertake all reasonable legal efforts to calculate An undertaking discloses any tax-related contingent liabilities current tax liability correctly. At the same time tax planning and contingent assets (see IAS 37). Contingent liabilities, and schemes, which are not present at balance sheet date, are not contingent assets, may arise from unresolved disputes with the taken into account for IAS 12 does not allow this. tax authorities. Abbreviations used: Similarly, where changes in tax rates, or tax laws, are enacted, or announced, after the balance sheet date, an undertaking 1. TAX - Russian tax calculation

62 www.banks2ifrs.ru 2. IFRS - IFRS accounting

3. DTL - Deferred tax liability

4. DTA - Deferred tax asset

63 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

All financial Interest income and Accruals are taxable and Temporary The differences may arise when assets and expenses/ deductible. special types of accrual are used (e.g. liabilities Accruals amortized cost). Result recognized in IFRS will be recognized later in TAX.

Interest expenses in Permanent Excess expenses won’t be ever Yes excess of 1.1 of CBR recognized. refinancing rate for RR and 15% for USD (article #269 of the Tax Code) are not deductible. Permanent Yes Non-market Excess expenses recognized in IFRS income/expenses (article won’t be ever recognized in TAX. #40 of the Tax Code) not Excess income recognized in TAX adjusted for the purposes won’t be ever recognized in IFRS. of IAS 39. All financial Fair value adjustment These adjustments are not Temporary Result recognized in IFRS will be assets and under IFRS 9 taxable/deductible. But if recognized later in TAX. E.g. when the liabilities the financial instrument is instrument will be disposed off before exchanged for the similar maturity. instrument with market interest rate the resulting interests will be taxed / deducted.

http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Loans/ Provision for loan Provisions created for first Temporary Result recognized in IFRS will be Interbank impairment group of risk are not recognized later in TAX since all deductible. accounting ‘losses’ become deductible There is no difference when REAL problems occur and the between secured and company can assign to loan higher unsecured loans. group of risk. Loans/ Provision for Provisions are not Temporary Result recognized in IFRS will be Yes Interbank/ promissory notes deductible. recognized later in TAX when all Securities accounting ‘losses’ become deductible Exceptions for securities (eg. through sale of the bad Provisions are deductible promissory note with loss). only for professional participants holding the dealer’s license. When promissory notes become overdue and there is legal evidence that the Bank would incur losses (decision of the court; sale of the promissory note to third party with losses; etc.) it is deductible.

65 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Securities Dealing gains/ Revaluation is not Temporary The MTM will be realized in future losses deductible/taxable. Only periods when the security will be realized results are disposed off. Thus it will be recognized deductible/taxable. in TAX. Yes Note that clients not possessing professional licenses have to account for dealing gains/losses using different baskets. The result of each basket Yes can’t be offset against each other. Permanent Excess expenses recognized in IFRS Non-market won’t be ever recognized in TAX. income/expenses (articles Excess income recognized in TAX #40 and #280 of the Tax won’t be ever recognized in IFRS. Code). E.g. the Tax authorities may recalculate the prices of deals for listed securities using “convenient” quotations. Securities Interest income All results are taxable Temporary The differences may arise when (including accruals). But special types of accrual are used (e.g. different tax rates are used amortized cost). Result recognized in (see below). IFRS will be recognized later in TAX.

66 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Securities Coupon income on All results are taxable Temporary The differences may arise when RR federal, subfederal (including accruals). special types of accrual are used (e.g. and municipal bonds Special rate applies to amortised cost). these gains – 15%. Permanent (reconciling The difference between the basic rate item) of 20% and 15% should be shown as reconciling item. Securities Dividend income All results are taxable at Permanent If they are material we should gross source. Special rate (reconciling them up. applies to these gains – item) Dr. Income tax paid 6%. Cr. Dividends received

The difference between the basic rate of 20% and 6% should be shown as reconciling item.

67 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Investments Equity accounting Capital gains are taxed at Temporary The difference may be recognized in in subs, 20%. TAX later when the investment will be associates sold. Permanent But the company may (reconciling If the management plans to receive decide to receive the gains item) dividends use 6%. from the investment in the form of dividends. Then 6% is applicable.

If the company doesn’t Permanent The differences from investments may have intentions to sell (but these not be recognized if: investment forever and differences are 1) the parent, investor or venturer is has the same intentions not disclosed able to control the timing of the concerning dividends in reconciling reversal of the temporary difference; THEN these differences table. They 2) and it is probable that the temporary will never have tax are shown difference will not reverse in the implications. separately) foreseeable future

To identify the type of difference we should consider the intentions of the management (sale or dividends).

68 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Investments Fair value accounting The same rules (see Temporary The provisions of IAS 12 allowing not available for preceding para) are to recognize DTL if the company can sale applicable to these control the timing of the reversal of the gains/losses. temporary difference are not applicable here since the definition of the investment available for sale involves the point that it will be realized in the foreseeable future. Investments Goodwill Amortization of goodwill is Permanent IAS 12 states that if amortization of in subs, not deductible under Tax goodwill is not deductible than this associates rules. difference should be permanent. Fixed assets Fixed assets Revaluation performed Temporary Difference will be realized either Yes revaluation before 1 January 2002 is through sale of a fixed asset or deductible. through cash flows generated by the Revaluation performed in asset in the future. RAS accounts after 1 January 2002 is not If the tax treatment is approved by the deductible. client and our tax specialist we should Revaluation performed on calculate the temporary difference 1 January 2002 may be between two revaluations (RAS and deductible (not more that IFRS) and recognize the deferred tax 30% of the book value as liability (DTL) or deferred tax asset at 01 January 2001). (DTA). The corresponding entry will be There is ambiguity in tax to equity. legislation. But the treatment may be in favour of client.

69 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Fixed assets Depreciation Only depreciation within Temporary Differences between TAX and IFRS tax rates is deductible. rates will become deductible either through sale of a fixed asset or through cash flows generated by the asset in the future. Thus they will lead to either to DTA or DTL. Fixed assets Non-production Fixed Depreciation and losses Permanent If cost of purchase is greater than Yes Assets from sale of fixed assets IFRS value than the tax value must be used for non-production equal to IFRS value. purposes are never deductible. Temporary The excess of an IFRS value of the BUT gains received from asset and tax base leads to DTL. the sale are likely to be taxable. Other Assets/ Forex Net losses from non- Temporary This is an example of tax loss carried Yes Liabilities deliverable forwards on forward. It can be used to decrease OTC market may be the current tax liabilities in future carried forward to future periods. We should estimate the periods (not more than 10 recoverability of the asset and years, not more than 30% consider the creation of provision for it. of the taxable profit).

70 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Other Assets/ Forex/ Revaluation of off-balance Temporary Irrespective of taxability/deductibility Yes Liabilities Securities/Precious sheet position is the revaluation will be realized in metals (Term deals) taxable/deductible future periods when the delivery or depending on the policy offset will occur. Thus it will be chosen by the company. recognized in TAX. Tax base equals zero. Thus IFRS value multiplied by tax rate = DTL/DTA. Other Provision for credit Provisions for credit Temporary When the payment under the Yes liabilities related commitments related commitments are guarantee is made and there is legal not deductible. evidence that the Bank will incur losses (decision of the court; sale of the debt to third party with losses; etc.) it will be deductible. Other Accruals of expenses General rule: all expenses Temporary Accruals in IFRS will be paid in cash in Yes liabilities on other operations are deductible. future periods thus they will be deductible in TAX. But expenses in excess of Permanent norms are not deductible: Excess expenses recognized in IFRS 1) Advertisement (% from won’t be ever recognized in TAX. salary) 2) Representative expenses (% from salary) 3) R&D expenses (less than 70% of the incurred expenses.

71 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

Other assets Unused tax loss It can be used during 10 Temporary It can be used to decrease the current Yes carried forward years but not more than tax liabilities in future periods. We 30% of the current year should estimate the recoverability of profits. the asset and consider the creation of provision for it. Other assets DTA N/A N/A We should consider the recoverability of DTA. The major question is if the company will have enough taxable profits in next periods to utilize the DTA in full.

72 www.banks2ifrs.ru Tax treatment IAS 12 Rationale Consult Balance sheet Nature of difference treatment with tax area specialist?

General Income/ The treatment of income and Permanent The difference between the basic rate Yes expenses created expenses earned and incurred (reconciling of 20% and offshore rate should be in SPVs, offshore zones through SPVs and depends on the tax regulations item) shown as reconciling item. offshore zones valid for those territories. THUS the calculation of DTL for Examples: the consolidating SPV should 1) Dealing gains and be separate from the major one. Subsequently the calculations losses; are consolidated. 2) Interest earned/ incurred in other tax Usually such income and zones while the asset/ expenses are subject to the tax liability is located in rate different from the major If the gains will be transferred to main zone. rate. Temporary/ Russian entity then they will be subject BUT if there is an agreement Permanent to Russian tax rules. E.g. interest will between the SPV and Russian be taxed at 20%. entity of the group to transfer the income/expenses then transferred results will be taxed using Russian tax rules. Permanent Excess expenses recognized in IFRS The rules of non-market won’t be ever recognized in TAX. income/expenses (articles #40 Excess income recognized in TAX and #280 of the Tax Code) may won’t be ever recognized in IFRS. be applicable. E.g. the Tax authorities may recalculate the prices of deals for listed securities using “convenient” quotations.

73 www.banks2ifrs.ru 4. Permanent differences require adjustments in the: 1. Periods prior to the transaction. 15 Multiple Choice Questions 2. The periods relating to the transaction. 3. Periods following the transaction. 1.IAS 12 prescribes the accounting treatment for income 4. Both 2 & 3. taxes, and the tax consequences of: 5. Deferred tax assets are the taxes recoverable, in future (i) Transactions of the current period that are recorded periods, in respect of: in an undertaking's financial statements. (ii) The future liquidation of the of assets and liabilities (i) Deductible temporary differences. that are recorded in an undertaking's balance sheet. (ii) Unused tax losses. (iii) Tax planning opportunities. (iii) Unused tax credits. 1. (i) 2. (i)-(ii). 3. (i)-(iii) (iv) Taxable temporary differences.

2. If liquidation of carrying amounts will make future tax 1. (i) payments larger or smaller, IAS 12 generally requires an 2. (i)-(ii). undertaking to record a 3. (i)-(iii) 1. Deferred tax liability (or deferred tax asset). 4. (i)-(iv) 2. Provision. 3. Contingent liability.

3. Permanent differences require: 1.Deferred tax liability (or deferred tax asset). 2. Provision. 3. Contingent liability. 4. None of these.

74 www.banks2ifrs.ru 6. Deferred tax relates to: 10. If revenue is taxed in the period received, the tax base: (i) Deductible temporary differences. 1. Is nil. 2. Is only nil if the revenue is recognised in the same (ii) Unused tax losses. period. 3. Is only nil if the revenue is recognised in the (iii) Unused tax credits. following period. 4. Is the amount received. (iv) Taxable temporary differences. 11. Research and development costs may be expensed in (v) Permanent differences. the current period, but deductible for tax purposes over subsequent periods. The tax base: 1. (i). 1. Is nil. 2. (i)-(ii). 2. Is the amount of the deduction that can be claimed 3. (i)-(iii). in future periods. 4. (i)-(iv). 3. Is the amount expensed. 5. (i)-(v). 12. Temporary differences arise: 7. Deferred tax 1. When the carrying amount of an asset or liability 1. Reverses over time. differs from its tax base. 2. May reverse over time. 2. When deferred tax is applied. 3. Does not reverse. 3. When deferred tax differs from current tax.

8. The use of deferred tax: 13. A deductible temporary difference generates a 1. Change the dates of payment of tax. 1. Deferred tax Liability. 2. May change the dates of payment of tax. 2. Deferred tax Asset. 3. Does not change the dates of payment of any tax. 3. Either 1 or 2.

9. If the tax already paid exceeds the tax due for the period, 14. A taxable temporary difference gives rise to: the excess will be recorded as: 1. Deferred tax Liability. 1. Deferred tax. 2. Deferred tax Asset. 2. A permanent difference. 3. Either 1 or 2. 3. An asset.

75 www.banks2ifrs.ru 15. Taxable temporary differences occur when tax is charged 18. Not all temporary differences are recognised as deferred in a period: tax balances.

1. Before the accounting period benefits from the The exceptions are: income in the financial accounts. (i) Goodwill. 2. After the accounting period benefits from the income in the financial accounts. (ii) Initial recognition of certain assets and liabilities.

3. Either 1 or 2. (iii) Certain investments.

(iv) Property revaluations. 16. Deductible temporary differences occur when tax is 1. (i). charged in a period: 2. (i)-(ii). 3. (i)-(iii). 1. Before the accounting period benefits from the 4. (i)-(iv). income in the financial accounts. 19. The realisation of deferred tax assets depends on: 2. After the accounting period benefits from the 1. Accounting profits being available in the future. income in the financial accounts. 2. Taxable profits being available in the future. 3. Either 1 or 2. 3. No increase in the rate of income tax.

17. Differences arising from fair value adjustments are treated: 20. When different rates of tax apply to different types and amounts of taxable income: 1.The same as any other taxable and deductible 1. An average rate is used. differences. 2. No deferred tax is charged. 3. Each item must be listed. 2. Differently depending on whether they arise on acquisition or otherwise. 21. An undertaking should review unrecorded deferred tax 3. Separately for deferred tax. assets to determine whether new conditions will permit the recovery of the asset: 76 www.banks2ifrs.ru 1. Every 3 years. 2. Every 5 years. (iii) Exchange differences, arising on the translation of the 3. At each balance sheet date. financial statements of a foreign undertaking.

22. The carrying amount of a deferred tax asset should be (iv)Amounts arising on initial recognition of the equity reviewed for: component of a compound financial instrument.

(i) Changes in tax rates. 1. (i). 2. (i)-(ii). (ii) Changes in the expected manner of recovery of an asset. 3. (i)-(iii). 4. (i)-(iv). (iii) Changes in future profits. 16 Answers to multiple choice questions 1. (i). Question Answer 2. (i)-(ii). 1. 2 3. (i)-(iii). 2. 1 3. 4 23. The difference between the carrying amount of a revalued 4. 2 asset and its tax base is a: 5. 3 1. Temporary difference. 6. 4 2. Permanent difference. 7. 1 3. Either 1 or 2. 8. 3 9. 3 24. Standards require or permit certain items to be credited, 10. 1 or charged, directly to equity. Examples of such items are: 11. 2 12. 1 (i) A change in carrying amount arising from the revaluation of property, plant and equipment; 13. 2 14. 1 (2) An adjustment to the opening balance of retained 15. 2 earnings, resulting from either a change in accounting 16. 1 policy applied retrospectively, or the correction of an 17. 1 error. IAS 8 has seriously limited this application. 18. 3 19. 2 77 www.banks2ifrs.ru 20. 1 Calculate the deferred tax. 21. 3 22. 3 3. In the next example, the cash is received and taxed in year 23. 1 1, but the income is split between years 1, 2 and 3. 24. 4 Year 1 Year 2 Year 3 Income 2000 2000 2000 17 NUMERICAL QUESTIONS Tax expense @ -1200 0 0 20% 1. -Permanent Differences Net profit 800 2000 2000 Your firm receives a $80million grant to employ more staff. It is tax- free. It is later fined $20m for environmental misuse, Calculate the deferred tax. after illegally discharging chemicals into a river. The fine cannot be deducted for tax. 4. If a transaction takes place in year 1 and tax is credited in Your tax computation will reconcile these adjustments to the year 2, year 1 will show a transaction without a tax credit, accounting profit. and year 2 will show a tax credit without a transaction:

Accounting Profit = $ 4.860 m Year 1 Year 2 Expense -1000 0 Assuming that both items are taken into profit in full in the Tax income @ 0 +200 same period, calculate the tax computation. 20% Net profit -1000 +200 2. If a transaction takes place in year 1 and tax is paid in year 2, year 1 will show a transaction without a tax charge, and Calculate the deferred tax. year 2 will show a tax charge without a transaction: 5. Tax is credited on payment of the money in period 1, but only treated as an expense in period 2. Year 1 Year 2 Income 400 0 Year 1 Year 2 Tax expense @ 0 -80 Expense 0 -300 20% Tax income @ +60 0 Net profit 400 -80 20% Net profit +60 -300 78 www.banks2ifrs.ru The remaining $150m is the tax base at the end of year 1, Calculate the deferred tax and will be allowed over the next 3 years.

6. The cash is paid and credited for tax in year 1, but the Provide the journal entries for years 1 & 2. expense is split between years 1, 2 and 3. Year 1 Year 2 Year 3 10. Revenue of 400 from the sale of goods is included in pre- Expense -2000 -2000 -2000 tax accounting profit when goods are delivered in year 1, but Tax income @ +1200 0 0 may be included in taxable profit when cash is collected in 20% year 2. Net profit -800 -2000 -2000 Provide the journal entries for years 1 & 2. Calculate the deferred tax 11. Development costs of 1.000 have been capitalised for 7. Tax expense split between the income statement and accounting purposes and will be amortised to the income equity. statement, but have been deducted as an expense in Your tax computation shows an expense of $187m for the determining taxable profit in the period in which they were year, of which $30m relates to a property revaluation. incurred. Amortised over 4 years starting in year 2.

Provide the journal entries. Provide the journal entries for years 1 & 2.

8. Tax loss: asset 12. Pension payments of 1.000 are recorded in year 1 for Your tax computation shows a loss of $16m for the year, accounting purposes and but only for tax purposes when paid which can be carried back to recover tax of a previous tax in cash in year 2. period. Provide the journal entries for years 1 & 2. Provide the journal entries. 9. Research and development costs You spend $200m on research in the current period, and it is 13. An impairment loss of $100m of property is recorded for treated as an expense. Tax authorities only allow the accounting purposes is ignored for tax purposes. expense to be deducted over a 4-year period. Only $50m is allowed in this period. Provide the journal entries.

79 www.banks2ifrs.ru 14. Financial instruments are carried at fair value, revaluing This is a current liability of $700. The tax authorities agree them with a gain of 400, but no matching revaluation is made that the loss for tax purposes. may be used to reduce the liability.

Provide the journal entries. Provide the journal entries for years 1 & 2.

15. Goodwill impairment charge of 4.000 is not deductible for tax purposes.

Provide the journal entries.

16. 40.000 of the retained earnings of controlled undertakings are included in consolidated retained earnings, but taxes are only paid on profits when distributed to the parent.

Provide the journal entries.

17. Tax rates changes

You have a temporary taxable difference of $400m. The rate of income tax is 24%.

In the next year, an official announcement is made that the income tax rate will fall to 20%.

Provide the journal entries for years 1 & 2.

18. Offset Your firm has carry-forward tax losses of $55m that are recorded as a current asset. You have a tax charge for the year in the same tax jurisdiction.

80 www.banks2ifrs.ru IAS 11 CONSTRUCTION CONTRACTS

18 ANSWERS TO NUMERICAL QUESTIONS Net profit 1600 1600 1600

1. 4. Year 1 Year 2 $m Expense -1000 0 Accounting Profit 4.860 Tax income @ 0 +200 Less grant -80 20% Plus fine +20 Deferred tax @ +200 -200 =Taxable profit 4.800 20% Tax charge = 4.800 * 20% = 960 Net profit -800 0

I/B DR CR 5. Tax expense I 0.96m Year 1 Year 2 Accrual for income tax B 0.96m Expense 0 -300 Tax expense for the period Tax income @ +60 0 20% 2. Deferred tax @ -60 +60 Year 1 Year 2 20% Income 400 0 Net profit 0 -240 Tax expense @ 0 -80 20% 6. Deferred tax @ -80 80 Year 1 Year 2 Year 3 20% Expense -2000 -2000 -2000 Net profit 320 0 Tax income @ 1200 0 0 20% 3. Deferred tax @ -800 +400 +400 Year 1 Year 2 Year 3 20% Income 2000 2000 2000 Net profit -1600 -1600 -1600 Tax expense @ -1200 0 0 20% 7. Deferred tax @ +800 -400 -400 20% http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 81 IAS 11 CONSTRUCTION CONTRACTS

Tax expense split between the income statement and equity. Tax credit @ 20% I 40m Your tax computation shows an expense of $187m for the year, Current tax liability (reduction) B 10m of which $30m relates to a property revaluation. Deferred tax asset B 30m I/B DR CR Research cost and tax income -period Tax expense – income statement I 157m 1 Tax expense-revaluation reserve B 30m Current tax liability (reduction) B 10m Tax accrual B 187m Deferred tax asset B 10m Tax expense split between the income Tax income -period 2 (and the same statement and equity for periods 3 & 4)

8. 10. Tax loss: asset Revenue from the sale of goods is included in pre-tax accounting Your tax computation shows a loss of $16m for the year, which profit when goods are delivered, but may be included in taxable can be carried back to recover tax of a previous tax period. profit when cash is collected. I/B DR CR I/B DR CR Tax recoverable B 16m Accounts receivable B 400 Tax income I 16m Revenue I 400 Recording recoverable tax loss Deferred tax liability B 80 Tax expense @ 20% I 80 Receipt of cash and tax recognition 9. -period 1 Research and development costs Cash B 400 You spend $200m on research in the current period, and it is Accounts receivable B 400 treated as an expense. Tax authorities only allow the expense to Deferred tax liability B 96 be deducted over a 4-year period. Only $50m is allowed in this Current tax liability B 96 period. Receipt of cash and tax liability recognition -period 2 The remaining $150m is the tax base at the end of year 1, and will be allowed over the next 3 years.

I/B DR CR 11. Research cost I 200m Cash B 200m http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 82 IAS 11 CONSTRUCTION CONTRACTS

Development costs have been capitalised for accounting Cost and tax income recognition purposes and will be amortised to the income statement, but -period 2 have been deducted as an expense in determining taxable profit in the period in which they were incurred. Amortised over 4 years, 13. starting from the year after they were incurred. An impairment loss of $100m of property is recorded for I/B DR CR accounting purposes is ignored for tax purposes; Development costs (capitalised) B 1000 I/B DR CR Cash B 1000 Impairment of property I 100m Current tax (reduction) @ 20% B 200 Accumulated depreciation of property B 100m Deferred tax liability B 200 Tax income @ 20% I 20m Development costs capitalised but Deferred tax asset B 20m allowed for tax credit -period 1 Recording impairment charge and Depreciation – development costs I 250 (deferred) tax charge Accumulated depreciation B 250 Deferred tax liability B 50 14. Tax income @ 20% I 50 Financial instruments are carried at fair value, revaluing them Depreciation and adjustment for tax with a gain of 400, but no matching revaluation is made for tax -period 2 purposes. I/B DR CR 12. Financial instrument B 400 Pension payments of 1.000 are recorded in year 1 for accounting Gain – fair value adjustment I 400 purposes and but only for tax purposes when paid in cash in year Tax expense @ 20% I 80 2. Deferred tax liability B 80 I/B DR CR Revaluation of financial instrument Pension expense I 1000 Accrual B 1000 Deferred tax asset B 200 Tax income @ 20% I 200 Accrual of pension costs Cash B 1000 Accrual B 1000 15. Current tax (reduction) @ 20% B 200 Goodwill impairment charge of 4.000 is not deductible for tax Deferred tax asset B 200 purposes. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 83 IAS 11 CONSTRUCTION CONTRACTS

I/B DR CR Deferred tax liability B 16m Impairment-goodwill I 4000 Tax income (or reduction of tax expense) – I 16m Goodwill B 4000 deferred tax Impairment of goodwill. Change of rate of deferred liability NO DEFERRED TAX LIABILITY IS 18. RECORDED. Offset Your firm has carry-forward tax losses of $55m that are recorded 16. as a current asset. 40.000 of the retained earnings of controlled undertakings are You have a tax charge for the year in the same tax jurisdiction. included in consolidated retained earnings, but taxes are only This is a current liability of $700. The tax authorities agree that paid on profits when distributed to the parent. the loss I/B DR CR may be used to reduce the liability. Net assets of subsidiary B 40000 I/B DR CR Profits/retained earnings I/B 40000 Tax loss-current asset B 55m Deferred tax liability B 8000 Tax income I 55m Tax expense @ 20% I 8000 Recording previous year tax loss Tax expense I 700m 17. Tax liability B 700m Tax rates changes Recording tax charge Tax liability B 55m You have a temporary taxable difference of $400m. The rate of Tax loss-current asset B 55m income tax is 24%. Offsetting carry- forward loss against current liability In the next period, an official announcement is made that the income tax rate will fall to 20%. Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook: The deferred tax liability will be reduced to $400m * 20% = $80m. (This example assumes that all of the deferred tax relates to the -Applying IFRS, IFRS News, Accounting Solutions income statement.) I/B DR CR Deferred tax liability B 96m Tax expense – deferred tax I 96m Creation of a deferred tax liability http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 84

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